[Federal Register Volume 85, Number 178 (Monday, September 14, 2020)]
[Proposed Rules]
[Pages 56846-56922]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-16532]
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 /
Proposed Rules
[[Page 56846]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-107911-18]
RIN 1545-BP73
Limitation on Deduction for Business Interest Expense; Allocation
of Interest Expense by Passthrough Entities; Dividends Paid by
Regulated Investment Companies; Application of Limitation on Deduction
for Business Interest Expense to United States Shareholders of
Controlled Foreign Corporations and to Foreign Persons With Effectively
Connected Income
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This notice of proposed rulemaking provides rules concerning
the limitation on the deduction for business interest expense after
amendment of the Internal Revenue Code (Code) by the provisions
commonly known as the Tax Cuts and Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus Aid, Relief, and Economic
Security Act, which was enacted on March 27, 2020. Specifically, these
proposed regulations address application of the limitation in contexts
involving passthrough entities, regulated investment companies (RICs),
United States shareholders of controlled foreign corporations, and
foreign persons with effectively connected income in the United States.
These proposed regulations also provide guidance regarding the
definitions of real property development, real property redevelopment,
and a syndicate. These proposed regulations affect taxpayers that have
business interest expense, particularly passthrough entities, their
partners and shareholders, as well as foreign corporations and their
United States shareholders and foreign persons with effectively
connected income. These proposed regulations also affect RICs that have
business interest income, RIC shareholders that have business interest
expense, and members of a consolidated group.
DATES: Written or electronic comments and requests for a public hearing
must be received by November 2, 2020, which is 60 days after the date
of filing for public inspection with the Office of the Federal
Register.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically. Submit electronic submissions via the Federal
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-107911-
18) by following the online instructions for submitting comments. Once
submitted to the Federal eRulemaking Portal, comments cannot be edited
or withdrawn. The IRS expects to have limited personnel available to
process public comments that are submitted on paper through mail. The
Department of the Treasury (Treasury Department) and the IRS will
publish for public availability any comment submitted electronically,
and when practicable on paper, to its public docket.
Send paper submissions to: CC:PA:LPD:PR (REG-107911-18), Room 5203,
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning Sec. 1.163(j)-1, Steven
Harrison, (202) 317-6842, Michael Chin, (202) 317-6842 or John
Lovelace, (202) 317-5363; concerning Sec. 1.163(j)-2, Sophia Wang,
(202) 317-4890 or John Lovelace, (202) 317-5363, concerning Sec.
1.163-14, Sec. 1.163(j)-6, or Sec. 1.469-9, William Kostak, (202)
317-5279 or Anthony McQuillen, (202) 317-5027; concerning Sec. 1.163-
15, Sophia Wang, (202) 317-4890; concerning Sec. 1.163(j)-7 or Sec.
1.163(j)-8, Azeka J. Abramoff, (202) 317-3800 or Raphael J. Cohen,
(202) 317-6938, concerning Sec. 1.1256(e)-2, Sophia Wang, (202) 317-
4890 or Pamela Lew, (202) 317-7053; concerning submissions of comments
and/or requests for a public hearing, Regina L. Johnson, (202) 317-5177
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) under sections 163 (in particular section
163(j)), 469 and 1256(e) of the Code. Section 163(j) was amended as
part of Public Law 115-97, 131 Stat. 2054 (December 22, 2017), commonly
referred to as the Tax Cuts and Jobs Act (TCJA), and the Coronavirus
Aid, Relief, and Economic Security Act, Public Law 116-136 (2020)
(CARES Act). Section 13301(a) of the TCJA amended section 163(j) by
removing prior section 163(j)(1) through (9) and adding section
163(j)(1) through (10). The provisions of section 163(j) as amended by
section 13301 of the TCJA are effective for tax years beginning after
December 31, 2017. The CARES Act further amended section 163(j) by
redesignating section 163(j)(10), as amended by the TCJA, as new
section 163(j)(11), and adding a new section 163(j)(10) providing
special rules for applying section 163(j) to taxable years beginning in
2019 or 2020.
Section 163(j) generally limits the amount of business interest
expense (BIE) that can be deducted in the current taxable year (also
referred to in this Preamble as the current year). Under section
163(j)(1), the amount allowed as a deduction for BIE is limited to the
sum of (1) the taxpayer's business interest income (BII) for the
taxable year; (2) 30 percent of the taxpayer's adjusted taxable income
(ATI) for the taxable year (30 percent ATI limitation); and (3) the
taxpayer's floor plan financing interest expense for the taxable year
(in sum, the section 163(j) limitation). As further described later in
this Background section, section 163(j)(10), as amended by the CARES
Act, provides special rules relating to the ATI limitation for taxable
years beginning in 2019 or 2020. Under section 163(j)(2), the amount of
any BIE that is not allowed as a deduction in a taxable year due to the
section 163(j) limitation is treated as business interest paid in the
succeeding taxable year.
The section 163(j) limitation applies to all taxpayers, except for
certain small businesses that meet the gross receipts test in section
448(c) and certain trades or businesses listed in section 163(j)(7).
Section 163(j)(3) provides that the section 163(j) limitation does not
apply to any taxpayer that meets the gross receipts test under section
448(c), other than a tax shelter prohibited from using the cash
receipts and disbursements method of accounting under section
448(a)(3).
Section 163(j)(4) provides special rules for applying section
163(j) in the case of passthrough entities. Section 163(j)(4)(A)
requires that the section 163(j) limitation be applied at the
partnership level, and that a partner's ATI be increased by the
partner's share of excess taxable income, as defined in section
163(j)(4)(C), but not by the partner's distributive share of income,
gain, deduction, or loss. Section 163(j)(4)(B) provides that the amount
of partnership BIE limited by section 163(j)(1) (EBIE) is carried
forward at the partner level. Section 163(j)(4)(B)(ii) provides that
EBIE allocated to a partner and carried forward is available to be
deducted in a subsequent year only to the extent that the partnership
allocates excess taxable income to the partner. As further described
later in this Background section, section 163(j)(10), as amended by the
CARES Act, provides a special rule for excess business interest expense
allocated to a partner in a taxable year beginning in 2019.
[[Page 56847]]
Section 163(j)(4)(B)(iii) provides rules for the adjusted basis in a
partnership of a partner that is allocated EBIE. Section 163(j)(4)(D)
provides that rules similar to the rules of section 163(j)(4)(A) and
(C) apply to S corporations and S corporation shareholders.
Section 163(j)(5) and (6) define ``business interest'' and
``business interest income,'' respectively, for purposes of section
163(j). Generally, these terms include interest expense and interest
includible in gross income that is properly allocable to a trade or
business (as defined in section 163(j)(7)) and do not include
investment income or investment expense within the meaning of section
163(d). The legislative history states that ``a corporation has neither
investment interest nor investment income within the meaning of section
163(d). Thus, interest income and interest expense of a corporation is
properly allocable to a trade or business, unless such trade or
business is otherwise explicitly excluded from the application of the
provision.'' H. Rept. 115-466, at 386, fn. 688 (2017).
Under section 163(j)(7), the limitation on the deduction for
business interest expense in section 163(j)(1) does not apply to
certain trades or businesses (excepted trades or businesses). The
excepted trades or businesses are the trade or business of providing
services as an employee, electing real property businesses, electing
farming businesses, and certain regulated utility businesses.
Section 163(j)(8) defines ATI as the taxable income of the taxpayer
without regard to the following: Items not properly allocable to a
trade or business; business interest and business interest income; net
operating loss (NOL) deductions; and deductions for qualified business
income under section 199A. ATI also generally excludes deductions for
depreciation, amortization, and depletion with respect to taxable years
beginning before January 1, 2022, and it includes other adjustments
provided by the Secretary of the Treasury.
Section 163(j)(9) defines ``floor plan financing interest'' as
interest paid or accrued on ``floor plan financing indebtedness.''
These provisions allow taxpayers incurring interest expense for the
purpose of securing an inventory of motor vehicles held for sale or
lease to deduct the full expense without regard to the section 163(j)
limitation.
Under section 163(j)(10)(A)(i), the amount of business interest
that is deductible under section 163(j)(1) for taxable years beginning
in 2019 or 2020 is computed using 50 percent, rather than 30 percent,
of the taxpayer's ATI for the taxable year (50 percent ATI limitation).
A taxpayer may elect not to apply the 50 percent ATI limitation to any
taxable year beginning in 2019 or 2020, and instead apply the 30
percent ATI limitation. This election must be made separately for each
taxable year. Once the taxpayer makes the election, the election may
not be revoked without the consent of the Secretary of the Treasury or
his delegate. See section 163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and 163(j)(10)(A)(iii) provide that,
in the case of a partnership, the 50 percent ATI limitation does not
apply to partnerships for taxable years beginning in 2019, and the
election to not apply the 50 percent ATI limitation may be made only
for taxable years beginning in 2020, and may be made only by the
partnership. Under section 163(j)(10)(A)(ii)(II), however, a partner
treats 50 percent of its allocable share of a partnership's excess
business interest expense for 2019 as a business interest expense in
the partner's first taxable year beginning in 2020 that is not subject
to the section 163(j) limitation (50 percent EBIE rule). The remaining
50 percent of the partner's allocable share of the partnership's excess
business interest expense remains subject to the section 163(j)
limitation applicable to excess business interest expense carried
forward at the partner level. A partner may elect out of the 50 percent
EBIE rule.
Section 163(j)(10)(B)(i) allows a taxpayer to elect to substitute
its ATI for the last taxable year beginning in 2019 (2019 ATI) for the
taxpayer's ATI for a taxable year beginning in 2020 (2020 ATI) in
determining the taxpayer's section 163(j) limitation for the taxable
year beginning in 2020.
Section 163(j)(11) provides cross-references to provisions
requiring that electing farming businesses and electing real property
businesses excepted from the section 163(j) limitation use the
alternative depreciation system (ADS), rather than the general
depreciation system, for certain types of property. The required use of
ADS results in the inability of these electing trades or businesses to
use the additional first-year depreciation deduction under section
168(k) for those types of property.
On December 28, 2018, the Department of the Treasury (Treasury
Department) and the IRS (1) published proposed regulations under
section 163(j), as amended by the TCJA, in a notice of proposed
rulemaking (REG-106089-18) (2018 Proposed Regulations) in the Federal
Register (83 FR 67490), and (2) withdrew the notice of proposed
rulemaking (1991-2 C.B. 1040) published in the Federal Register on June
18, 1991 (56 FR 27907 as corrected by 56 FR 40285 (August 14, 1991)) to
implement rules under section 163(j) before amendment by the TCJA. The
2018 Proposed Regulations were issued following guidance announcing and
describing regulations intended to be issued under section 163(j). See
Notice 2018-28, 2018-16 I.R.B. 492 (April 16, 2018).
A public hearing on the 2018 Proposed Regulations was held on
February 27, 2019. The Treasury Department and the IRS also received
written comments responding to the 2018 Proposed Regulations (available
at http://www.regulations.gov). In response to certain comments, the
Treasury Department and the IRS are publishing this notice of proposed
rulemaking to provide additional proposed regulations (these Proposed
Regulations) under section 163(j).
Concurrently with the publication of these Proposed Regulations,
the Treasury Department and the IRS are publishing in the Rules and
Regulations section of this edition of the Federal Register (RIN 1545-
BO73) final regulations under section 163(j) (the Final Regulations).
On April 10, 2020, the Treasury Department and the IRS released
Revenue Procedure 2020-22, 2020-18 I.R.B. 745, to provide the time and
manner of making a late election, or withdrawing an election, under
section 163(j)(7)(B) to be an electing real property trade or business
or section 163(j)(7)(C) to be an electing farming business for taxable
years beginning in 2018, 2019, or 2020. Revenue Procedure 2020-22 also
provides the time and manner of making or revoking elections provided
by the CARES Act under section 163(j)(10) for taxable years beginning
in 2019 or 2020. As described earlier in this Background section, these
elections are: (1) To not apply the 50 percent ATI limitation under
section 163(j)(10)(A)(iii); (2) to use the taxpayer's 2019 ATI to
calculate the taxpayer's section 163(j) limitation for any taxable year
beginning in 2020 under section 163(j)(10)(B); and (3) for a partner to
elect out of the 50 percent EBIE rule under section
163(j)(10)(A)(ii)(II).
Explanation of Provisions
These Proposed Regulations would provide guidance in addition to
the Final Regulations regarding the section 163(j) limitation. These
Proposed Regulations would also add or amend regulations under certain
other provisions of the Code where necessary
[[Page 56848]]
to provide conformity across the Income Tax Regulations. A significant
number of the terms used throughout these Proposed Regulations are
defined in Sec. 1.163(j)-1 of the Final Regulations and discussed in
the Explanation of Provisions section of the 2018 Proposed Regulations
and the Summary of Comments and Explanation of Revisions section of the
Final Regulations. Some of these terms are further discussed in this
Explanation of Provisions section as they relate to specific provisions
of these Proposed Regulations.
Part I of this Explanation of Provisions describes proposed rules
that would allocate interest expense for purposes of sections 469,
163(d), 163(h), and 163(j) in connection with certain transactions
involving passthrough entities. Part II provides proposed rules
relating to distributions of debt proceeds from any taxpayer account or
from cash so that interest expense may be allocated for purposes of
sections 469, 163(d), 163(h), and 163(j). Part III describes proposed
modifications to the definitions and general guidance in Sec.
1.163(j)-1, including proposed rules permitting taxpayers to apply a
different computational method in determining adjustments to tentative
taxable income to address sales or other dispositions of depreciable
property, stock of a consolidated group member, or interests in a
partnership, and proposed rules allowing RIC shareholders to treat
certain RIC dividends as interest income for purposes of section
163(j). Part IV describes proposed modifications to Sec. 1.163(j)-6,
relating to the applicability of the section 163(j) limitation to
passthrough entities, including proposed rules on the applicability of
the section 163(j) limitation to trading partnerships and publicly
traded partnerships, the application of the section 163(j) limitation
in partnership self-charged lending transactions, proposed rules
relating to the treatment of excess business interest expense in tiered
partnerships, proposed rules relating to partnership basis adjustments
upon partner dispositions, proposed rules regarding the election to
substitute 2019 ATI for the partnership's 2020 ATI in determining the
partnership's section 163(j) limitation for a taxable year beginning in
2020, and proposed rules regarding excess business interest expense
allocated to a partner in a taxable year beginning in 2019.
Part V discusses re-proposed rules regarding the application of the
section 163(j) limitation to foreign corporations and United States
shareholders (as defined in section 951(b) (U.S. shareholders) of
controlled foreign corporations (as defined in section 957(a)) (CFCs).
Part VI discusses re-proposed rules regarding the application of the
section 163(j) limitation to nonresident alien individuals and foreign
corporations with effectively connected income in the United States.
Part VII describes proposed modifications to the definition of a real
property trade or business under Sec. 1.469-9 for purposes of the
passive activity loss rules and the definition of an electing real
property trade or business under section 163(j)(7)(B). Part VIII
describes proposed rules regarding the definition of a ``tax shelter''
for purposes of Sec. 1.163(j)-2 and section 1256(e), as well as
proposed rules regarding the election to use 2019 ATI in determining
the taxpayer's section 163(j) limitation for a taxable year beginning
in 2020. Part IX describes proposed modifications regarding the
application of the corporate look-through rules to tiered structures.
I. Proposed Sec. 1.163-14: Allocation of Interest Expense With Respect
to Passthrough Entities
Section 1.163-8T provides rules regarding the allocation of
interest expense for purposes of applying the passive activity loss
limitation in section 469, the investment interest limitation in
section 163(d), and the personal interest limitation in section 163(h)
(such purposes, collectively, Sec. 1.163-8T purposes). Under Sec.
1.163-8T, debt generally is allocated by tracing disbursements of the
debt proceeds to specific expenditures and interest expense associated
with debt is allocated for Sec. 1.163-8T purposes in the same manner
as the debt to which such interest expense relates. When debt proceeds
are deposited to the borrower's account, and the account also contains
unborrowed funds, Sec. 1.163-8T(c) provides that the debt generally is
allocated to expenditures by treating subsequent expenditures from the
account as made first from the debt proceeds to the extent thereof. The
rules further provide that if the proceeds of two or more debts are
deposited in the account, the proceeds are treated as expended in the
order in which they were deposited. In addition to these rules, Sec.
1.163-8T also provides specific rules to address reallocation of debt,
repayments and refinancing.
The preamble to Sec. 1.163-8T (52 FR 24996) stated that ``interest
expense of partnerships and S corporations, and of partners and S
corporation shareholders, is generally allocated in the same manner as
the interest expense of other taxpayers.'' The preamble acknowledged
the need for special rules for debt financed distributions to owners of
partnerships and S corporations, and for cases in which taxpayers incur
debt to acquire or increase their capital interest in the passthrough
entity, but reserved on these issues and requested comments.
In a series of notices, the Treasury Department and the IRS
provided further guidance with respect to the allocation of interest
expense in connection with certain transactions involving passthrough
entities and owners of passthrough entities. See Notice 88-20, 1988-1
C.B. 487, Notice 88-37, 1988-1 C.B. 522, and Notice 89-35, 1989-1 C.B.
675. Specifically, Notice 89-35 provides, in part, rules addressing the
treatment of (1) a passthrough entity owner's debt allocated to
contributions to, or purchases of, interests in a passthrough entity
(debt-financed contributions or acquisitions), and (2) passthrough
entity debt allocated to distributions by the entity to its owners
(debt-financed distributions).
In the case of a debt-financed acquisition of an interest in a
passthrough entity by purchase (rather than by way of a contribution to
the capital of the entity), Notice 89-35 provides that the interest
expense of the owner of the passthrough entity, for Sec. 1.163-8T
purposes, is allocated among the assets of the entity using any
reasonable method. A reasonable method for this purpose includes, for
example, allocating the debt among all of the assets of the passthrough
entity based on the fair market value, the book value, or the adjusted
basis of the assets, reduced by the amount of any debt of the entity or
the amount of any debt that the owner of the entity allocates to such
assets. Notice 89-35 also provides that interest expense on debt
proceeds allocated to a contribution to the capital of a passthrough
entity shall be allocated using any reasonable method for Sec. 1.163-
8T purposes. For this purpose, any reasonable method includes
allocating the debt among the assets of the passthrough entity or
tracing the debt proceeds to the expenditures of the passthrough
entity.
In the case of debt-financed distributions, Notice 89-35 provides a
general allocation rule and an optional allocation rule. The general
allocation rule applies the principles of Sec. 1.163-8T to interest
expense associated with debt-financed distributions by applying a
tracing approach to determine the character of the interest expense for
Sec. 1.163-8T purposes. Under this approach, the debt proceeds and the
associated interest expense related to a debt-financed distribution are
allocated under Sec. 1.163-8T in accordance with
[[Page 56849]]
the use of the distributed debt proceeds by the distributee owner of
the passthrough entity. To the extent an owner's share of a passthrough
entity's interest expense related to the debt-financed distribution
exceeds the entity's interest expense on the portion of the debt
proceeds distributed to that particular owner, Notice 89-35 provides
that the passthrough entity may allocate such excess interest expense
using any reasonable method.
The optional allocation rule applicable to debt-financed
distributions allows a passthrough entity to allocate distributed debt
proceeds and the associated interest expense to one or more
expenditures, other than distributions, of the entity that are made
during the same taxable year of the entity as the distribution, to the
extent that debt proceeds, including other distributed debt proceeds,
are not otherwise allocated to such expenditures. Under the optional
allocation rule, distributed debt proceeds are traced to the owner's
use of the borrowed funds to the extent that such distributed debt
proceeds exceed the entity's expenditures, not including distributions,
for the taxable year to which debt proceeds are not otherwise
allocated.
While the 2018 Proposed Regulations did not include rules to
further address the application of Sec. 1.163-8T to passthrough
entities, the Treasury Department and the IRS received comments
indicating that, for purposes of section 163(j), a tracing rule based
on how a passthrough entity owner uses the proceeds of a debt-financed
distribution does not align well with the statutory mandate in section
163(j)(4) to apply section 163(j) at the passthrough entity level.
Based on these comments and a review of the rules under Sec. 1.163-8T,
the Treasury Department and the IRS have determined that additional
rules, specific to passthrough entities and their owners, are needed to
clarify how the rules under Sec. 1.163-8T work when applied to a
passthrough entity and to account for the entity-level limitation under
section 163(j)(4).
A. In General
The rules of Sec. 1.163-8T generally apply to partnerships, S
corporations, and their owners and the rules in proposed Sec. 1.163-14
would provide additional rules for purposes of applying the Sec.
1.163-8T rules to passthrough entities. As with the rules under Sec.
1.163-8T, proposed Sec. 1.163-14 would provide that interest expense
on a debt incurred by a passthrough entity is allocated in the same
manner as the debt to which such interest relates is allocated, and
that debt is generally allocated by tracing disbursements of the debt
proceeds to specific expenditures.
The Treasury Department and the IRS have determined that the scope
of Sec. 1.163-8T(a)(4) and (b) is not appropriate in the passthrough
entity context. Section 1.163-8T(a)(4) generally provides rules
regarding the treatment of interest expense allocated to specific
expenditures, which are described in Sec. 1.163-8T(b). However, the
list of expenditures described in Sec. 1.163-8T(b) is based on an
allocation of interest for purposes of applying sections 163(d),
163(h), and 469, and does not adequately account for the uses of debt
proceeds by a passthrough entity (for example, distributions to
owners).
To more accurately account for the types of expenditures made by
passthrough entities, proposed Sec. 1.163-14(b) would provide rules
tailored to passthrough entities. In addition, the framework that
proposed Sec. 1.163-14(b) would provide is needed for a passthrough
entity to determine how much of its interest expense is allocable to a
trade or business for purposes of applying section 163(j). These
proposed regulations would apply before a passthrough entity applies
any of the rules in section 163(j) (including Sec. 1.163(j)-10).
In application, a passthrough entity would continue to apply the
operative rules in Sec. 1.163-8T to allocate debt and the interest
expense associated with such debt. However, instead of generally
tracing debt proceeds to the types of expenditures described under
Sec. 1.163-8T(b) and treating any interest expense associated with
such debt proceeds in the manner described under Sec. 1.163-8T(a)(4),
a passthrough entity would generally trace debt proceeds to the types
of expenditures described under proposed Sec. 1.163-14(b)(2) and treat
any interest expense associated with such debt proceeds in the manner
provided under proposed Sec. 1.163-14(b)(1).
B. Debt Financed Distributions
Proposed Sec. 1.163-14 would provide that when debt proceeds of a
passthrough entity are allocated under Sec. 1.163-8T to distributions
to owners of the entity, the debt proceeds distributed to any owner and
the associated interest expense shall be allocated under proposed Sec.
1.163-14(d). In general, proposed Sec. 1.163-14(d) would adopt a rule
similar to Notice 89-35, but with the following modifications. First,
instead of providing that passthrough entities may use the optional
allocation rule, proposed Sec. 1.163-14(d) would generally provide
that passthrough entities are required to apply a rule that is similar
to the optional allocation rule. Second, instead of providing that the
passthrough entity may allocate excess interest expense using any
reasonable method, proposed Sec. 1.163-14(d) would generally provide
that the passthrough entity must allocate excess interest expense based
on the adjusted tax basis of the passthrough entity's assets.
Specifically, proposed Sec. 1.163-14(d)(1) would provide a rule
based in principle on the optional allocation rule in Notice 89-35.
Under this proposed rule, distributed debt proceeds (debt proceeds of a
passthrough entity allocated under Sec. 1.163-8T to distributions to
owners of the entity) would first be allocated under proposed Sec.
1.163-14(d)(1)(i) to the passthrough entity's available expenditures.
Available expenditures are those expenditures of a passthrough entity
made in the same taxable year as the distribution, but only to the
extent that debt proceeds (including other distributed debt proceeds)
are not otherwise allocated to such expenditure. This approach is
consistent with the concept that money is fungible (a passthrough
entity may be fairly treated as distributing non-debt proceeds rather
than debt proceeds and using debt proceeds rather than non-debt
proceeds to finance its non-distribution expenditures) and seeks to
coordinate the interest allocation rules with the entity-level approach
to passthroughs adopted in section 163(j). Where the distributed debt
proceeds exceed the passthrough entity's available expenditures, this
excess amount of distributed debt proceeds would be allocated to
distributions to owners of the passthrough entity (debt financed
distributions) under proposed Sec. 1.163-14(d)(1)(ii).
After determining the amount of its distributed debt proceeds
allocated to available expenditures and debt financed distributions, a
passthrough entity would use this information to determine the tax
treatment of each owner's allocable interest expense (that is, an
owner's share of interest expense associated with the distributed debt
proceeds allocated under section 704(b) or 1366(a)). To aid the
passthrough entity and owner in determining the tax treatment of each
owner's allocable interest expense, proposed Sec. 1.163-14(d)(2) would
provide rules for determining the portion of each owner's allocable
interest expense that is (1) debt financed distribution interest
expense, (2) expenditure interest expense, and (3) excess interest
expense. These three categories of allocable interest expense are
mutually
[[Page 56850]]
exclusive--e.g., a given dollar of allocable interest expense cannot
simultaneously be both debt financed distribution interest expense and
expenditure interest expense. The computations in proposed Sec. 1.163-
14(d)(2) would ensure this outcome.
Once a passthrough entity categorizes each owner's allocable
interest expense as described earlier, it would apply proposed Sec.
1.163-14(d)(3) to determine the tax treatment of such interest expense.
The manner in which the tax treatment of allocable interest expense is
determined depends on how such allocable interest expense was
categorized under proposed Sec. 1.163-14(d)(2).
Conceptually, each of the three categories described earlier, as
well as the prescribed tax treatment of interest expense in each
category, is discussed in Notice 89-35. Debt financed distribution
interest expense is referred to in Notice 89-35 as an owner's share of
a passthrough entity's interest expense on debt proceeds allocated to
such owner. Similar to Notice 89-35, proposed Sec. 1.163-14(d)(3)(i)
would generally provide that such interest expense is allocated under
Sec. 1.163-8T in accordance with the owner's use of the debt proceeds.
Further, expenditure interest expense is referred to in Notice 89-35 as
interest expense allocated under the optional allocation rule. Similar
to Notice 89-35, proposed Sec. 1.163-14(d)(3)(ii) would generally
provide that the tax treatment of such interest expense is determined
based on how the distributed debt proceeds were allocated among
available expenditures. Finally, both Notice 89-35 and proposed Sec.
1.163-14(d) would use the term excess interest expense to refer to an
owner's share of allocable interest expense in excess of the entity's
interest expense on the portion of the debt proceeds distributed to
that particular owner. Unlike Notice 89-35, which generally allows any
reasonable method for determining the tax treatment of excess interest
expense, proposed Sec. 1.163-14(d)(3)(iii) would generally provide
that the tax treatment of excess interest expense is determined by
allocating the distributed debt proceeds among all the assets of the
passthrough entity, pro-rata, based on the adjusted basis of such
assets.
Proposed Sec. 1.163-14(d)(4) also would provide rules addressing
the tax treatment of the interest expense of a transferee owner where
the transferor had previously been allocated debt financed distribution
interest expense. In the case of a transfer of an interest in a
passthrough entity, any debt financed distribution interest expense of
the transferor generally shall be treated as excess interest expense by
the transferee. However, in the case of a transfer of an interest in a
passthrough entity to a person who is related to the transferor, any
debt financed distribution interest expense of the transferor shall
continue to be treated as debt financed distribution interest expense
by the related party transferee, and the tax treatment of such debt
financed distribution expense shall be the same to the related party
transferee as it was to the transferor. The term related party means
any person who bears a relationship to the taxpayer which is described
in section 267(b) or 707(b)(1).
The proposed regulations also would include an anti-avoidance rule
to recharacterize arrangements entered into with a principal purpose of
avoiding the rules of proposed Sec. 1.163-14(d), including the
transfer of an interest in a passthrough entity by an owner who treated
a portion of its allocable interest expense as debt financed
distribution interest expense to an unrelated party pursuant to a plan
to transfer the interest back to the owner who received the debt
financed distribution interest expense or to a party who is related to
the owner who received the debt financed distribution interest expense.
C. Operational Rules
Proposed Sec. 1.163-14 also would include several operational
rules that clarify the application of certain rules under Sec. 1.163-
8T as they apply to passthrough entities. Proposed Sec. 1.163-14(e)
would provide an ordering rule applicable to repayment of debt by
passthrough entities similar to the rules in Sec. 1.163-8T(d)(1).
Proposed Sec. 1.163-14(g) would provide that any transfer of an
ownership interest in a passthrough entity is not a reallocation event
for purposes of Sec. 1.163-8T(j), except as provided for in Sec.
1.163-14(d)(4).
D. Debt-Financed Acquisitions
Proposed Sec. 1.163-14(f) would adopt a rule providing that the
tax treatment of an owner's interest expense associated with a debt
financed acquisition (either by purchase or contribution) will be
determined by allocating the debt proceeds among the assets of the
entity. The owner would allocate the debt proceeds (1) in proportion to
the relative adjusted tax basis of the entity's assets reduced by any
debt allocated to such assets, or (2) based on the adjusted basis of
the entity's assets in accordance with the rules in Sec. 1.163(j)-
10(c)(5)(i) reduced by any debt allocated to such assets. The Treasury
Department and the IRS request comments regarding whether asset basis
(either adjusted tax basis or adjusted tax basis based on the rules in
Sec. 1.163(j)-10(c)(5)(i)) less the amount of debt allocated to assets
under Sec. Sec. 1.163-14 and 1.163-8T is appropriate as the sole
method for allocating interest expense in this context.
II. Proposed Sec. 1.163-15: Debt Proceeds Distributed From Any
Taxpayer Account or From Cash
Proposed Sec. 1.163-15 supplements the rules in Sec. 1.163-8T
regarding debt proceeds distributed from any taxpayer account or from
cash proceeds. Section 1.163-8T(c)(4)(iii)(B) provides that a taxpayer
may treat any expenditure made from an account within 15 days after the
debt proceeds are deposited in such account as being made from such
proceeds, regardless of any other rules in Sec. 1.163-8T(c)(4). Under
Sec. 1.163-8T(c)(5)(i), if a taxpayer receives debt proceeds in cash,
the taxpayer may treat any cash expenditure made within 15 days after
receiving the cash as being made from such debt proceeds, and may treat
such expenditure as being made on the date the taxpayer received the
cash. Commenters have suggested that the 15-day limit in Sec. 1.163-8T
could encourage taxpayers to keep separate accounts, rather than
commingled accounts for tracing purposes.
In Notice 88-20, 1988-1 C.B. 487, the IRS announced the intention
to issue regulations providing that, for debt proceeds deposited in an
account on or before December 31, 1987, taxpayers could treat any
expenditure made from any account of the taxpayer or from cash within
30 days before or after debt proceeds are deposited in such account or
any other account of the taxpayer as made from such proceeds. The
Notice states that the regulations also would provide that for debt
proceeds received in cash on or before December 31, 1987, taxpayers may
treat any expenditure made from any account of the taxpayer or from
cash within 30 days before or after debt proceeds are received in cash
as made from such proceeds. Section VI of Notice 89-35 adopts the
standard described in Notice 88-20 without the date limitation,
although no regulations have been issued.
Consistent with Notice 89-35, proposed Sec. 1.163-15 provides that
taxpayers may treat any expenditure made from an account of the
taxpayer or from cash within 30 days before or after debt proceeds are
deposited in any account of the taxpayer or received in cash as made
from such proceeds.
[[Page 56851]]
III. Proposed Modifications to Sec. 1.163(j)-1(b): Definitions
A. Adjustments to Tentative Taxable Income
Section 1.163(j)-1(b)(1) requires taxpayers to make certain
adjustments to tentative taxable income in computing ATI, including
adjustments to address certain sales or other dispositions of
depreciable property, stock of a consolidated group member (member
stock), or interests in a partnership. More specifically, Sec.
1.163(j)-1(b)(1)(ii)(C) provides that, if property is sold or otherwise
disposed of, the greater of the allowed or allowable depreciation,
amortization, or depletion of the property for the taxpayer (or, if the
taxpayer is a member of a consolidated group, the consolidated group)
for taxable years beginning after December 31, 2017, and before January
1, 2022 (such years, the EBITDA period), with respect to such property
is subtracted from tentative taxable income. Section 1.163(j)-
1(b)(1)(ii)(D) provides that, with respect to the sale or other
disposition of stock of a member of a consolidated group by another
member, the investment adjustments under Sec. 1.1502-32 with respect
to such stock that are attributable to deductions described in Sec.
1.163(j)-1(b)(1)(ii)(C) are subtracted from tentative taxable income.
Section 1.163(j)-1(b)(1)(ii)(E) provides that, with respect to the sale
or other disposition of an interest in a partnership, the taxpayer's
distributive share of deductions described in Sec. 1.163(j)-
1(b)(1)(ii)(C) with respect to property held by the partnership at the
time of such sale or other disposition is subtracted from tentative
taxable income to the extent such deductions were allowable under
section 704(d). See the preamble to the Final Regulations for a
discussion of the rationale for these adjustments.
The preamble to the Final Regulations noted that, in the 2018
Proposed Regulations, Sec. 1.163(j)-1(b)(1)(ii)(C) incorporated a
``lesser of'' standard. In other words, the lesser of (i) the amount of
gain on the sale or other disposition of property, or (ii) the amount
of depreciation deductions with respect to such property for the EBITDA
period, was required to be subtracted from tentative taxable income to
determine ATI. As explained in the preamble to the Final Regulations,
commenters raised several questions regarding this ``lesser of''
standard. The Final Regulations removed the ``lesser of'' approach due
in part to concerns that this approach would be more difficult to
administer than the approach reflected in the Final Regulations.
However, the Treasury Department and the IRS recognize that, in
certain cases, the ``lesser of'' approach might not create
administrative difficulties for taxpayers. Thus, these Proposed
Regulations permit taxpayers to choose whether to compute the amount of
their adjustment using a ``lesser of'' standard. While the 2018
Proposed Regulations applied this standard solely to dispositions of
property, these Proposed Regulations extend this standard to
dispositions of partnership interests and member stock to eliminate the
discontinuity between the amount of the adjustment for these different
types of dispositions. Taxpayers opting to use this alternative
computation method must do so for all sales or other dispositions that
otherwise would be subject to Sec. 1.163(j)-1(b)(1)(ii)(C), (D), or
(E) when the taxpayer computes tentative taxable income.
The Treasury Department and the IRS request comments on the
``lesser of'' approach, including how such an approach should apply to
dispositions of member stock and partnership interests.
B. Dividends From Regulated Investment Company (RIC) Shares
Some commenters on the 2018 Proposed Regulations recommended that
dividend income from a RIC be treated as interest income for a
shareholder in a RIC, to the extent that the income earned by the RIC
is interest income. Because a RIC is a subchapter C corporation,
section 163(j) applies at the RIC level, and any BIE that is disallowed
at the RIC level is carried forward to subsequent years at the RIC
level. Furthermore, because a RIC is a subchapter C corporation, a
shareholder in a RIC generally does not take into account a share of
the RIC's items of income, deduction, gain, or loss. Thus, if a RIC's
BII exceeds its BIE in a taxable year, the RIC may not directly
allocate the excess amount to its shareholders (unlike a partnership,
which may allocate excess BII to its partners).
Under part 1 of subchapter M and other Code provisions, however, a
RIC that has certain items of income or gain may pay dividends that a
shareholder in the RIC may treat in the same manner (or a similar
manner) as the shareholder would treat the underlying items of income
or gain if the shareholder realized the items directly. Although this
treatment differs fundamentally from the passthrough treatment of
partners or trust beneficiaries, this Explanation of Provisions refers
to this treatment as ``conduit treatment.'' For example, under sections
871(k)(1) and 881(e)(1), a RIC that has qualified interest income
within the meaning of section 871(k)(1)(E) may pay interest-related
dividends, and no tax generally would be imposed under sections
871(a)(1)(A) or 881(a)(1) on an interest-related dividend paid to a
nonresident alien individual or foreign corporation. Section 871(k)(1)
provides necessary limits and procedures that apply to interest-related
dividends. The Code provides similar conduit treatment for capital gain
dividends in section 852(b)(3), exempt-interest dividends in section
852(b)(5), short-term capital gain dividends in section 871(k)(2),
dividends eligible for the dividends received deduction in section
854(b)(1)(A), and qualified dividend income in section 854(b)(1)(B).
In response to comments, these Proposed Regulations provide rules
under which a RIC that earns BII may pay section 163(j) interest
dividends. A shareholder that receives a section 163(j) interest
dividend may treat the dividend as interest income for purposes of
section 163(j), subject to holding period requirements and other
limitations. A section 163(j) interest dividend that meets these
requirements is treated as BII if it is properly allocable to a non-
excepted trade or business of the shareholder. A section 163(j)
interest dividend is treated as interest income solely for purposes of
section 163(j).
The rules under which a RIC may report section 163(j) interest
dividends are based on the rules for reporting exempt-interest
dividends in section 852(b)(5) and interest-related dividends in
section 871(k)(1). The total amount of a RIC's section 163(j) interest
dividends for a taxable year is limited to the excess of the RIC's BII
for the taxable year over the sum of the RIC's BIE for the taxable year
and the RIC's other deductions for the taxable year that are properly
allocable to the RIC's BII. For some types of income and gain to which
conduit treatment applies, the gross amount of the RIC's income or gain
of that type serves as the limit on the RIC's corresponding dividends.
It would be inconsistent with the purposes of section 163(j) to permit
a RIC to pay section 163(j) interest dividends in an amount based on
the RIC's gross BII, unreduced by the RIC's BIE. Further reducing the
limit on a RIC's section 163(j) interest dividends by the amount of the
RIC's other deductions that are properly allocable to the RIC's BII is
consistent with the provisions of the Code that provide conduit
treatment for types of interest earned by a RIC. For example, the limit
on interest-related dividends in section 871(k)(1)(D) is
[[Page 56852]]
reduced by the deductions properly allocable to the RIC's qualified
interest income. Similarly, the limit on exempt-interest dividends in
section 852(b)(5)(A)(iv)(V) is reduced by the amounts disallowed as
deductions under sections 265 and 171(a)(2). Taking into account the
appropriate share of deductions also reduces the likelihood that the
sum of a RIC's items that are eligible for conduit treatment and that
are relevant to a particular shareholder will exceed the amount of the
dividend distribution paid to the particular shareholder.
These Proposed Regulations contain an additional limit to prevent
inconsistent treatment of RIC dividends by RIC shareholders. Revenue
Ruling 2005-31, 2005-1 C.B. 1084, allows a RIC to report the maximum
amount of capital gain dividends, exempt-interest dividends, interest-
related dividends, short-term capital gain dividends, dividends
eligible for the dividends received deduction, and qualified dividend
income for a taxable year, even if the sum of the reported amounts
exceeds the amount of the RIC's dividends for the taxable year. The
ruling allows different categories of shareholders (United States
persons and nonresident aliens) to report the dividends they receive by
giving effect to the conduit treatment of the items relevant to them. A
single shareholder, however, generally does not benefit from the
conduit treatment of amounts in excess of the dividend paid to that
shareholder, because to do so would require the shareholder to include
in its taxable income amounts exceeding the dividend it received.
Conduit treatment of BII, however, differs from the conduit treatment
of other items, because a section 163(j) interest dividend is treated
as interest income only for purposes of section 163(j). Thus, absent a
limit, a RIC shareholder could obtain an inappropriate benefit by
treating a portion of a RIC dividend as interest income for purposes of
section 163(j) while treating the same portion of the dividend as
another non-interest type of income, such as a dividend eligible for
the dividends received deduction under sections 243 and 854(b).
Therefore, these Proposed Regulations limit the amount of a section
163(j) interest dividend that a shareholder may treat as interest
income for purposes of section 163(j) to the excess of the amount of
the RIC dividend that includes the section 163(j) interest dividend
over the sum of the portions of that dividend affected by conduit
treatment in the hands of that shareholder, other than interest-related
dividends under section 871(k)(1)(C) and section 163(j) interest
dividends.
Under these Proposed Regulations, a shareholder generally may not
treat a section 163(j) interest dividend as interest income unless it
meets certain holding period and similar requirements. The holding
period requirements do not apply to (i) dividends paid by a RIC
regulated as a money market fund under 17 CFR 270.2a-7 or (ii) certain
regular dividends paid by a RIC that declares section 163(j) interest
dividends on a daily basis and distributes such dividends on a monthly
or more frequent basis. The Treasury Department and the IRS request
comments on whether there are other categories of section 163(j)
interest dividends for which the holding period requirements should not
apply or should be modified. The Treasury Department and the IRS also
request comments on whether any payments that are substitutes for
section 163(j) interest dividends (for example, in a securities lending
or sale-repurchase transaction with respect to RIC shares) should be
treated for purposes of section 163(j) as interest expense of taxpayers
making the payments or interest income to taxpayers receiving the
payments. Cf. Sec. 1.163(j)-1(b)(22)(iii)(C) (addressing certain
payments that are substitutes for interest).
These Proposed Regulations, to the extent they concern the payment
of section 163(j) interest dividends by a RIC and the treatment of such
dividends as interest by a RIC shareholder, are proposed to apply to
taxable years beginning on or after the date that is 60 days after the
date the Treasury decision adopting these regulations as final
regulations is published in the Federal Register. Solely in the case of
section 163(j) interest dividends that would be exempt from the holding
period rules under these Proposed Regulations, the RIC paying such
dividends and the shareholders receiving such dividends may rely on the
provisions of these Proposed Regulations pertaining to section 163(j)
interest dividends for taxable years ending on or after September 14,
2020, and beginning before the date that is 60 days after the date the
Treasury decision adopting these regulations as final regulations is
published in the Federal Register.
IV. Proposed Sec. 1.163(j)-6: Application of the Business Interest
Expense Deduction Limitations to Partnerships and Subchapter S
Corporations
A. Trading Partnerships
The preamble to the 2018 Proposed Regulations states that the
business interest expense of certain passthrough entities, including S
corporations, allocable to trade or business activities that are
described in section 163(d)(5)(A)(ii) (i.e., activities that are per se
non-passive under section 469 in which the taxpayer does not materially
participate) and illustrated in Revenue Ruling 2008-12, 2008-1 C.B. 520
(March 10, 2008) (trading activities), will be subject to section
163(j) at the entity level, even if the interest expense is later
subject to limitation under section 163(d) at the individual partner or
shareholder level. Accordingly, at least with respect to partnerships,
to the extent that interest expense from a trading activity is limited
under section 163(j) and becomes a carryover item of partners who do
not materially participate in the trading activity, the interest
expense will be treated as investment interest in the hands of those
partners for purposes of section 163(d) once the interest expense is no
longer limited under section 163(j). As a result, the interest expense
would be subject to two section 163 limitations.
The Treasury Department and the IRS received multiple comments
questioning this interpretation of section 163(j)(5) and its
interaction with section 163(d)(5)(A)(ii). Specifically, commenters
stated that the interpretation improperly results in the application of
section 163(j) to partnerships engaged in a trade or business activity
of trading personal property (including marketable securities) for the
account of owners of interests in the activity, as described in Sec.
1.469-1T(e)(6) (trading partnerships). At issue is the extent to which
BIE of trading partnerships should be subject to limitation under
section 163(j). This issue involves the definition of BIE under section
163(j)(5) and, more specifically, the second sentence of section
163(j)(5), which generally provides that BIE shall not include
investment interest within the meaning of section 163(d).
The approach described in the preamble to the 2018 Proposed
Regulations interprets section 163(j)(5) as simply providing that
interest expense cannot be both BIE and investment interest expense in
the hands of the same taxpayer. Under this interpretation, section
163(j)(5) will treat interest as investment interest
[[Page 56853]]
where conflicting provisions may otherwise subject an amount of
interest expense to limitation under both section 163(j) and section
163(d) with respect to the same taxpayer (for example, interest expense
allocable to business assets comprising ``working capital'' as that
term is used in section 469(e)(1)(B)). In addition, this approach views
the partnership as an entity separate from its partners for purposes of
section 163(j) to the partnership and section 163(d) at the individual
partner level. Several commenters disagreed with this interpretation of
section 163(j)(5), asserting that the second sentence of section
163(j)(5) unequivocally provides that interest expense can never be
subject to limitation under both section 163(j) and section 163(d)
under any circumstances. Based on these comments, the Treasury
Department and the IRS considered three alternative approaches for
interpreting section 163(j)(5).
One approach would require a partnership engaged in a trading
activity to apply section 163(j) at the partnership level to all of the
partnership's interest expense from the trading activity. Under this
approach, any deductible interest expense from the partnership's
trading activity would not be subject to any further limitation under
section 163(d) at the individual partner level. This interpretation
would respect the partnership as an entity separate from its partners
for purposes of section 163(j), but would treat section 163(j)(4) and
(5) as superseding section 163(d)(5)(A)(ii).
A second approach would require a partnership engaged in a trading
activity to bifurcate its interest expense from a trading activity
between partners that materially participate in the trading activity
and partners that are passive investors in the activity, and subject
only the portion that is allocable to the materially participating
partners to limitation under section 163(j). Under this approach, to
the extent any interest expense is allocable to passive investors in
the trading activity, the interest expense would be subject only to
section 163(d) at the partner level and would never be subject to
section 163(j) at the partnership level.
A third approach would require a partnership to treat all of the
interest expense from a trading activity as investment interest under
section 163(d), regardless of whether any individual partners
materially participate in the trading activity. Under this approach,
the interest expense properly allocable to materially participating
partners would never be subject to limitation under section 163(j),
even though interest expense allocable to materially participating
partners would also not be subject to limitation under section 163(d)
at the individual partner level.
After considering the comments, Treasury Department and the IRS
have concluded that the approach described in the preamble to the 2018
Proposed Regulations is inconsistent with the statutory language and
intent of section 163(j)(5) because the second sentence of section
163(j)(5) specifically states that BIE shall not include investment
interest expense. In addition, the Treasury Department and the IRS have
determined that the second alternative approach, as described earlier,
appears to be the most consistent with the intent of sections 163(d)
and 163(j). Accordingly, these Proposed Regulations would interpret
section 163(j)(5) as requiring a trading partnership to bifurcate its
interest expense from a trading activity between partners that
materially participate in the trading activity and partners that are
passive investors, and as subjecting only the portion of the interest
expense that is allocable to the materially participating partners to
limitation under section 163(j) at the partnership level. The portion
of interest expense from a trading activity allocable to passive
investors will be subject to limitation under section 163(d) at the
partner level, as provided in section 163(d)(5)(A)(ii).
In addition, these Proposed Regulations require that a trading
partnership bifurcate all of its other items of income, gain, loss and
deduction from its trading activity between partners that materially
participate in the partnership's trading activity and partners that are
passive investors. The portion of the partnership's other items of
income, gain, loss or deduction from its trading activity properly
allocable to the passive investors in the partnership will not be taken
into account at the partnership level as items from a trade or business
for purposes of applying section 163(j) at the partnership level.
Instead, all such partnership items properly allocable to passive
investors will be treated as items from an investment activity of the
partnership, for purposes of sections 163(j) and 163(d).
This approach, in order to be effective, adopts the presumption
that a trading partnership generally will possess knowledge regarding
whether its individual partners are material participants in its
trading activity. No rules currently exist requiring a partner to
inform the partnership whether the partner has grouped activities of
the partnership with other activities of the partner outside of the
partnership. Therefore, the partnership might possess little or no
knowledge regarding whether an individual partner has made such a
grouping. Without this information, a trading partnership may presume
that an individual partner is a passive investor in the partnership's
trading activity based solely on the partnership's understanding as to
the lack of work performed by the partner in that activity, whereas the
partner may in fact be treated as a material participant in the
partnership's trading activity by grouping that activity with one or
more activities of the partner in which the partner materially
participates. In order to avoid this result and the potential for
abuse, a new rule is proposed for the section 469 activity grouping
rules to provide that any activity described in section
163(d)(5)(A)(ii) may not be grouped with any other activity of the
taxpayer, including any other activity described in section
163(d)(5)(A)(ii). The Treasury Department and the IRS invite comments
regarding whether other approaches may be feasible and preferable to a
special rule that prohibits the grouping of trading activities with
other activities of a partner, such as adoption of a rule or reporting
regime requiring all partners in the partnership to annually certify or
report to the partnership whether they are material participants in a
grouped activity that includes the partnership's trading activity.
The Treasury Department and the IRS further invite comments
regarding whether similar rules should be adopted with respect to S
corporations that may also be involved in trading activities, and
whether such rules would be compatible with Subchapter S (for example,
whether the bifurcation of items from the S corporation's trading
activity between material participants and passive investors would run
afoul of the second class of stock prohibition).
B. Fungibility of Publicly Traded Partnerships
In order to be freely marketable, each unit of a publicly traded
partnership (PTP), as defined in Sec. 1.7704-1, must have identical
economic and tax characteristics so that such PTP units are fungible.
For PTP units to be fungible, the section 704(b) capital account
associated with each unit must be economically equivalent to the
section 704(b) capital account of all other units of the same class,
and a PTP unit buyer must receive equivalent tax allocations regardless
of the specific unit purchased. In other words, from the
[[Page 56854]]
perspective of a buyer, a PTP unit cannot have variable tax attributes
depending on the identity of the PTP unit seller. In general, to
achieve fungibility, a PTP (1) makes a section 754 election, pursuant
to which a purchaser can insulate itself from its predecessor's
allocable section 704(c) gain or loss through a section 743(b) basis
adjustment, and (2) adopts the remedial allocation method under section
704(c) for all of its assets.
Pursuant to Sec. 1.704-3(d)(1), a partnership adopts the section
704(c) remedial allocation method to eliminate distortions caused by
the application of the ceiling rule, as defined in Sec. 1.704-3(b)(1),
under the section 704(c) traditional method. A partnership adopting the
remedial allocation method eliminates ceiling rule distortions by
creating remedial items and allocating those items to its partners.
Under the remedial allocation method, a partnership first determines
the amount of section 704(b) book items under Sec. 1.704-3(d)(2) and
the partners' section 704(b) distributive shares of such items. The
partnership then allocates the corresponding tax items recognized by
the partnership, if any, using the traditional method described in
Sec. 1.704-3(b)(1). If the ceiling rule causes the section 704(b) book
allocation of an item to a noncontributing partner to differ from the
tax allocation of the same item to the noncontributing partner, the
partnership creates a remedial item of income, gain, loss, or deduction
equal to the full amount of the difference and allocates it to the
noncontributing partner. The partnership simultaneously creates an
offsetting remedial item in an identical amount and allocates it to the
contributing partner. In sum, by coupling the remedial allocation
method with a section 754 election, PTP units remain fungible from a
net tax perspective, regardless of the PTP unit seller's section 704(c)
position.
However, even when the remedial allocation method is coupled with a
section 754 election, the application of section 163(j) in the
partnership context results in variable tax attributes for a buyer
depending upon the tax characteristics of the interest held by the
seller. The Treasury Department and the IRS have determined this is an
inappropriate result for PTPs because PTPs, unlike other partnerships,
always require that tax attributes be proportionate to economic
attributes to retain the fungibility of their units. The Treasury
Department and the IRS have determined that the manner in which section
163(j) applies in the partnership context should not result in the non-
fungibility of PTP units. Accordingly, these Proposed Regulations
provide a method, solely for PTPs, for applying section 163(j) in a
manner that does not result in PTP units lacking fungibility.
Specifically, commenters identified three ways in which the 2018
Proposed Regulations may cause PTP units to be non-fungible. First, the
method for allocating excess items may cause PTP units to be non-
fungible. In general, under Sec. 1.163(j)-6(f)(2), the allocation of
the components of ATI dictate the allocation of a partnership's
deductible BIE and section 163(j) excess items. Consequently, the
unequal sharing of inside basis, including cost-recovery deductions,
amortization, gain, and loss affects the ratio in which a partnership's
section 163(j) excess items, as defined in Sec. 1.163(j)-6(b)(6), are
shared. A partner's share of section 163(j) excess items affects the
tax treatment and economic consequences of the partner. For example, a
greater share of excess taxable income enables a partner subject to
section 163(j) to deduct more interest.
The Treasury Department and the IRS recognize that a non-pro rata
sharing of inside basis could result in a non-pro rata allocation of
excess items, which may result in PTP units lacking fungibility.
Therefore, these Proposed Regulations would amend Sec. 1.163(j)-
6(f)(1)(iii) to provide that, solely for purposes of section 163(j), a
PTP allocates section 163(j) excess items in accordance with the
partners' shares of corresponding section 704(b) items that comprise
ATI.
Second, the required adjustments to partner ATI for partner basis
items (e.g., section 743(b) income and loss) may cause PTP units to
lack fungibility. A non-pro rata sharing of inside basis may result in
a different allocation of partner basis items, as defined in Sec.
1.163(j)-6(b)(2), and section 704(c) remedial items, as defined in
Sec. 1.163(j)-6(b)(3), among partners. Pursuant to Sec. 1.163(j)-
6(d)(2), partner basis items and remedial items are not taken into
account in determining a partnership's ATI under Sec. 1.163(j)-
1(b)(1). Instead, partner basis items and section 704(c) remedial items
affect the tax treatment and economic consequences of the partner.
Similar to the disproportionate sharing of excess items discussed
earlier, the disproportionate sharing of partner basis items and
section 704(c) remedial items among partners may cause PTP units to
lack fungibility.
The Treasury Department and the IRS recognize that a non-pro rata
sharing of inside basis could result in different partner basis items
and remedial items being allocated to different partners. Therefore,
these Proposed Regulations would amend Sec. 1.163(j)-6(e)(2)(ii) to
provide that, solely for the purpose of determining remedial items
under section 163(j), a PTP either allocates gain or loss that would
otherwise be allocated under section 704(c) to a specific partner to
all partners based on each partner's section 704(b) sharing ratio, or,
for purposes of allocating cost recovery deductions under section
704(c), determines each partner's remedial items based on an allocation
of the partnership's inside basis items among its partners in
proportion to their share of corresponding section 704(b) items, rather
than applying the traditional method as described in Sec. 1.704-3(b).
Third, the treatment of section 704(c) remedial income allocations
for taxable years beginning before 2022 may cause PTP units to lack
fungibility. For taxable years beginning before January 1, 2022, when
tentative taxable income is not reduced by depreciation and
amortization deductions for purposes of determining ATI, a buyer
acquiring PTP units with section 704(c) remedial income allocations
(and an offsetting section 743(b) adjustment) will have an increase to
its ATI that exceeds that of a buyer of the same number of otherwise
fungible units that is not stepping into section 704(c) remedial income
(with no corresponding section 743(b) deduction). While the net amount
of the section 743(b) and section 704(c) remedial items is the same to
both buyers, for taxable years beginning before January 1, 2022,
different units would affect a buyer's ATI differently. The section
704(c) remedial income of a buyer of units with section 704(c) remedial
income would be included in its ATI, while the section 743(b)
deductions would not. Thus, a buyer of units with section 704(c)
remedial income would increase its ATI each year (before 2022). A buyer
of units with no section 704(c) remedial income, however, would add
back any remedial depreciation and amortization deductions before 2022,
and its ATI would be unaffected by the remedial deductions for such
years.
The Treasury Department and the IRS recognize that, before 2022, a
buyer of PTP units with inherent section 704(c) gain would include any
remedial income and would not include section 743(b) deductions in its
ATI. Therefore, these Proposed Regulations would amend Sec. 1.163(j)-
6(d)(2)(ii) to provide that, solely for purposes of section 163(j), a
PTP treats the amount of any section 743(b) adjustment of a purchaser
of a partnership unit that relates to a remedial item that the
purchaser inherits from the seller as an offset to
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the related section 704(c) remedial item. The Treasury Department and
the IRS request comments as to whether the approaches outlined
adequately resolves the fungibility issues created by section 163(j).
C. Treatment of Business Interest Income and Business Interest Expense
With Respect to Lending Transactions Between a Partnership and a
Partner (Self-Charged Lending Transactions)
The 2018 Proposed Regulations reserved on the treatment of BII and
BIE with respect to lending transactions between a partnership and a
partner (self-charged lending transactions). The preamble to the 2018
Proposed Regulations requested comments regarding self-charged lending
transactions. One commenter recommended the final regulations include
rules under Sec. 1.163(j)-6(n) akin to those contained in Sec. 1.469-
7 to identify self-charged interest income and expense and further
allow such self-charged interest income and expense to be excluded from
the definition of BIE and BII under section 163(j)(5) and (6),
respectively. The same commenter recommended that the final regulations
retain the rule in Sec. 1.163(j)-3(b)(4), as set forth in the 2018
Proposed Regulations, which applies the section 163(j) limitation prior
to the application of the passive activity loss rules of section 469.
Other commenters recommended the Final Regulations exclude BIE and BII
from the section 163(j) calculation where a partner or S-corporation
shareholder lends to, or borrows from, a passthrough entity. These
commenters recommended that the amount excluded be based on the amount
of income or expense recognized by partners or shareholders that are
lenders or borrowers, as well as partners or shareholders that are
related to a lender or borrower partner within the meaning of section
267(b) because it would be appropriate to exclude the BII and BIE
realized by the related parties for purposes of the section 163(j)
calculation.
In response to these comments, the Treasury Department and the IRS
propose adding a rule in proposed Sec. 1.163(j)-6(n) to provide that,
in the case of a lending transaction between a partner (lending
partner) and partnership (borrowing partnership) in which the lending
partner owns a direct interest (self-charged lending transaction), any
BIE of the borrowing partnership attributable to the self-charged
lending transaction is BIE of the borrowing partnership for purposes of
Sec. 1.163(j)-6. If in a given taxable year the lending partner is
allocated EBIE from the borrowing partnership and has interest income
attributable to the self-charged lending transaction (interest income),
the lending partner shall treat such interest income as an allocation
of excess business interest income (EBII) from the borrowing
partnership in such taxable year, but only to the extent of the lending
partner's allocation of EBIE from the borrowing partnership in such
taxable year. To prevent the double counting of BII, the lending
partner includes interest income that was re-characterized as EBII
pursuant to proposed Sec. 1.163(j)-6(n) only once when calculating the
lending partner's own section 163(j) limitation. In cases where the
lending partner is not a C corporation, to the extent that any interest
income exceeds the lending partner's allocation of EBIE from the
borrowing partnership for the taxable year, and such interest income
otherwise would be properly treated as investment income of the lending
partner for purposes of section 163(d) for that year, such excess
amount of interest income will continue to be treated as investment
income of the lending partner for that year for purposes of section
163(d).
The Treasury Department and the IRS generally agree that lending
partners should not be adversely affected by the fact that, without
special rules, the interest income received at the partner level from
such lending transactions generally will be treated as investment
income if the partner is not engaged in the trade or business of
lending money, while the BIE of the partnership will be subject to
section 163(j) and potentially limited at the partner level as EBIE.
This situation would create a mismatch between the character of the
interest income and of the interest expense at the partner level from
the same lending transaction. These proposed rules would apply only to
items of interest income attributable to the lending transaction and
EBIE from the same partnership that arise in the same taxable year of
the lending partner. By applying these proposed rules only to correct a
mismatch in character that may occur at the partner level during a
single taxable year, these proposed rules otherwise ensure that a
partnership engaged in a self-charged lending transaction will be
subject to the rules of section 163(j) to the same extent regardless of
the sources of its loans.
These proposed rules will not apply in the case of an S corporation
because BIE of an S corporation is carried over by the S corporation as
a corporate-level attribute rather than immediately passed through to
its shareholders. In the year such disallowed BIE is deductible at the
corporate level, it is not separately stated, and it is not subject to
further limitation under section 163(j) at either the S corporation or
shareholder level. Therefore, a limited self-charged rule to ensure
proper matching of the character of interest income and BIE at the
shareholder level is not necessary. This approach is consistent with
the treatment of S corporations as separate entities from their owners,
both generally and specifically with respect to section 163(j).
However, the Treasury Department and the IRS recognize that issues
analogous to the issues faced by partnerships in self-charged lending
transactions exist with respect to lending transactions between S
corporations and their shareholders. The Treasury Department and the
IRS request comments on whether a similar rule is appropriate for S
corporations in light of section 163(j)(4)(B) not applying and, if so,
how such rule should be structured.
D. Partnership Basis Adjustments Upon Partner Dispositions
In general, a partnership's disallowed BIE is allocated to its
partners as EBIE rather than carried forward at the partnership level
in order to prevent the trafficking of deductions for BIE carryforwards
in the partnership context. To achieve this, section
163(j)(4)(B)(iii)(I) provides that the adjusted basis of a partner in a
partnership interest is reduced (but not below zero) by the amount of
EBIE allocated to the partner. If a partner disposes of a partnership
interest, section 163(j)(4)(B)(iii)(II) provides that the adjusted
basis of the partner in the partnership interest is increased
immediately before the disposition by the amount of any EBIE that was
not treated as BIE paid or accrued by the partner prior to the
disposition. Further, under section 163(j)(4)(B)(iii)(II), no deduction
shall be allowed to the transferor or transferee for any EBIE resulting
in a basis increase.
The Treasury Department and the IRS have determined that the basis
increase required by section 163(j)(4)(B)(iii)(II) is not fully
descriptive of what is occurring when a partner with EBIE disposes of
its partnership interest. If EBIE is not treated as BIE paid or accrued
by the partner pursuant to Sec. 1.163(j)-6(g) prior to the partner
disposing of its partnership interest (nondeductible EBIE), section
163(j)(4)(B)(iii)(II) treats such nondeductible EBIE as though it were
a nondeductible expense of the partnership.
[[Page 56856]]
This nondeductible expense is not a nondeductible, non-
capitalizable expense under section 705(a)(2)(B). If it were, the
partner's basis in its partnership interest at the time of the
disposition would already reflect such an expense. Instead, section
163(j)(4)(B)(iii)(II) requires the partner to increase its basis
immediately before the disposition--in effect, treating the partner as
though the partnership made a payment that decreased the value of the
partnership interest but did not affect the partner's basis in its
partnership interest. Thus, upon a disposition, section 163(j)(4)
treats nondeductible EBIE as though it were a nondeductible,
capitalizable expense of the partnership.
While the statute is clear that a partner increases the basis in
its partnership interest immediately prior to a disposition by any
nondeductible EBIE, it does not specifically state that there must also
be a corresponding increase to the basis of partnership assets to
account for the nondeductible, capitalized expense (i.e., the
nondeductible EBIE). The absence of a corresponding increase to the
partnership's basis immediately before the partner's disposition would
create distortions that are inconsistent with the intent of both
section 163(j) and subchapter K of the Code.
For example, the basis increase attributable to nondeductible EBIE
immediately before a liquidating distribution results in less gain
recognized under section 731(a)(1) (or more loss recognized under
section 731(a)(2)) for the partner disposing of its partnership
interest. Consequently, following a liquidating distribution to a
partner with EBIE, section 163(j)(4)(B)(iii)(II) causes a reduced
section 734(b) adjustment if the partnership has a section 754 election
in effect (versus the partner basis increase not occurring), resulting
in basis disparity between the partnership's basis in its assets and
the aggregate outside basis of the remaining partners.
To illustrate, consider the following example. In Year 1, A, B, and
C formed partnership PRS by each contributing $1,000 cash. PRS borrowed
$900, causing each partner's basis in PRS to increase by $300. Also in
Year 1, PRS purchased Capital Asset X for $200. In Year 2, PRS pays
$300 of BIE, all of which is disallowed and treated as EBIE. PRS
allocated the $300 of EBIE to its partners, $100 each. Pursuant to
Sec. 1.163(j)-6(h)(2), each partner reduced its outside basis by its
$100 allocation of EBIE to $1,200. In Year 3, when the fair market
value of Capital Asset X is $3,200 and no partner's basis in PRS has
changed, PRS distributed $1,900 to C in complete liquidation of C's
partnership interest. PRS has a section 754 election in effect in Year
3.
Pursuant to Sec. 1.163(j)-6(h)(3), C increases the adjusted basis
of its partnership interest by $100 immediately before the disposition.
Thus, C's section 731(a)(1) gain recognized on the disposition of its
partnership interest is $900 (($1,900 cash + $300 relief of
liabilities)-($1,200 outside basis + $100 EBIE add-back)). Because the
election under section 754 is in effect, PRS has a section 734(b)
increase to the basis of its assets of $900 (the amount of section
731(a)(1) gain recognized by C). Under section 755, the entire
adjustment is allocated to Capital Asset X. As a result, PRS's basis
for Capital Asset X is $1,100 ($200 + $900 section 734(b) adjustment).
Following the liquidation of C, PRS's basis in its assets ($1,500 of
cash + $1,100 of Capital Asset X) does not equal the aggregate outside
basis of partners A and B ($2,700).
The Treasury Department and the IRS have determined that basis
disparity resulting from the absence of a corresponding inside basis
increase, as described earlier, is an inappropriate result.
Accordingly, these Proposed Regulations would provide for a
corresponding inside basis increase that would serve as the partnership
analog of section 163(j)(4)(B)(iii)(II). Specifically, proposed Sec.
1.163(j)-6(h)(5) would provide that if a partner (transferor) disposes
of its partnership interest, the partnership shall increase the
adjusted basis of partnership property by an amount equal to the amount
of the increase required under Sec. 1.163(j)-6(h)(3), if any, to the
adjusted basis of the partnership interest being disposed of by the
transferor. Such increase in the adjusted basis of partnership property
(Sec. 1.163(j)-6(h)(5) basis adjustment) shall be allocated among
partnership properties in the same manner as a positive section 734(b)
adjustment. Because a Sec. 1.163(j)-6(h)(5) basis adjustment is taken
into account when determining the gain or loss upon a sale of the
asset, a Sec. 1.163(j)-6(h)(5) basis adjustment prevents the shifting
of built-in gain to the remaining partners.
These Proposed Regulations would adopt an approach that treats the
increase in the adjusted basis of any partnership property resulting
from a Sec. 1.163(j)-6(h)(5) basis adjustment as not depreciable or
amortizable under any section of the Code, regardless of whether the
partnership property allocated such Sec. 1.163(j)-6(h)(5) basis
adjustment is otherwise generally depreciable or amortizable. This
approach perceives EBIE as a deduction that was disallowed to the
partnership (consistent with section 163(j)(4)(B)(iii)(II)), and thus
should not result in a depreciable section 734(b) basis adjustment.
The Treasury Department and the IRS request comments on this
approach. An alternative approach considered by the Treasury Department
and the IRS would treat a Sec. 1.163(j)-6(h)(5) basis adjustment as
depreciable or amortizable if it is allocated to depreciable or
amortizable property. However, section 163(j)(4)(B)(iii)(II) provides
that no deduction shall be allowed to the transferor or transferee for
any EBIE resulting in a basis increase to the partner that disposed of
its interest. If a Sec. 1.163(j)-6(h)(5) basis adjustment were
depreciable or amortizable, a partnership--which can arguably be viewed
as a transferee in a transaction in which a partner receives a
distribution in complete liquidation of its partnership interest--could
effectively deduct an expense that section 163(j)(4)(B)(iii)(II) states
is permanently disallowed. The Treasury Department and the IRS request
comments on whether treating a Sec. 1.163(j)-6(h)(5) basis adjustment
as potentially depreciable or amortizable is consistent with section
163(j)(4)(B)(iii)(II).
E. Treatment of Excess Business Interest Expense in Tiered Partnerships
1. Entity Approach
The preamble to the 2018 Proposed Regulations reserved and
requested comments on the application of section 163(j)(4) to tiered
partnership structures. Specifically, the preamble to the 2018 Proposed
Regulations requested comments regarding whether, in a tiered
partnership structure, EBIE should be allocated through an upper-tier
partnership to the partners of upper-tier partnership. Additionally,
comments were requested regarding how and when the basis of an upper-
tier partnership partner should be adjusted when a lower-tier
partnership has BIE that is limited under section 163(j).
In response, commenters recommended approaches that, in general,
either (1) allocated EBIE through upper-tier partnership to the
partners of upper-tier partnership (Aggregate Approach), or (2) did not
allocate EBIE through upper-tier partnership to the partners of upper-
tier partnership (Entity Approach). Commenters stated that both
approaches reasonably implement Congressional intent of applying
section 163(j) at the partnership level; however, the Entity
[[Page 56857]]
Approach reflects a stronger allegiance to entity treatment of
partnerships for purposes of section 163(j). Commenters noted that the
ultimate determination of which approach is more appropriate should
rest, in large part, on whether partnerships or partners are more able
to comply with the provision. The Entity Approach places more of that
burden on partnerships, and the Aggregate Approach places more of the
burden on partners. Commenters recommended that partnerships are better
able to comply with an Entity Approach than partners are able to comply
with an Aggregate Approach. Further, because the Entity Approach
centers a significant portion of the compliance effort with
partnerships, the Entity Approach may increase compliance and simplify
Service review.
The Treasury Department and the IRS have concluded that an Entity
Approach is the most consistent with the approach taken to partnerships
under section 163(j)(4). Further, the Treasury Department and the IRS
agree with commenters that partnerships are better able to comply with
section 163(j) tiered partnership rules than partners. Accordingly,
proposed Sec. 1.163(j)-6(j)(3) would provide that if lower-tier
partnership allocates excess business interest expense to upper-tier
partnership, then upper-tier partnership reduces its basis in lower-
tier partnership pursuant to Sec. 1.163(j)-6(h)(2). Upper-tier
partnership partners do not, however, reduce the bases of their upper-
tier partnership interests pursuant to Sec. 1.163(j)-6(h)(2) until
upper-tier partnership treats such excess business interest expense as
business interest expense paid or accrued pursuant to Sec. 1.163(j)-
6(g).
Although proposed Sec. 1.163(j)-6(j)(3) would provide that EBIE
allocated from a lower-tier partnership to an upper-tier partnership is
not subject to further allocation by the upper-tier partnership, such
EBIE necessarily reflects a reduction in the value of lower-tier
partnership by the amount of the economic outlay that resulted in such
EBIE. Accordingly, proposed Sec. 1.163(j)-6(j)(2) would provide that
if lower-tier partnership pays or accrues business interest expense and
allocates such business interest expense to upper-tier partnership,
then both upper-tier partnership and any direct or indirect partners of
upper-tier partnership shall, solely for purposes of section 704(b) and
the regulations thereunder, treat such business interest expense as a
section 705(a)(2)(B) expenditure. Any section 704(b) capital account
reduction resulting from such treatment occurs regardless of whether
such business interest expense is characterized under this section as
excess business interest expense or deductible business interest
expense by lower-tier partnership. If upper-tier partnership
subsequently treats any excess business interest expense allocated from
lower-tier partnership as business interest expense paid or accrued
pursuant to Sec. 1.163(j)-6(g), the section 704(b) capital accounts of
any direct or indirect partners of upper-tier partnership are not
further reduced.
2. Basis and Carryforward Component of EBIE
Some commenters stated that an Entity Approach--that is, the
approach these Proposed Regulations would adopt--would result in basis
disparity between upper-tier partnership's basis in its assets and the
aggregate basis of the upper-tier partners' interests in upper-tier
partnership. The Treasury Department and the IRS do not agree. EBIE is
neither an item of deduction nor a section 705(a)(2)(B) expense. If an
allocation of EBIE from lower-tier partnership results in a reduction
of the upper-tier partnership's basis in its lower-tier partnership
interest, there is not a net reduction in the tax attributes of the
upper-tier partnership. Rather, in such an event, upper-tier
partnership merely exchanges one tax attribute (tax basis in its lower-
tier partnership interest) for a different tax attribute (EBIE, which,
in a subsequent year, could result in either a deduction or a basis
adjustment). Thus, basis is preserved in this exchange.
Accordingly, proposed Sec. 1.163(j)-6(j)(4) would provide that if
lower-tier partnership allocates excess business interest expense to
upper-tier partnership and such excess business interest expense is not
suspended under section 704(d), then upper-tier partnership shall treat
such excess business interest expense (UTP EBIE) as a nondepreciable
capital asset, with a fair market value of zero and basis equal to the
amount by which upper-tier partnership reduced its basis in lower-tier
partnership pursuant to Sec. 1.163(j)-6(h)(2) due to the allocation of
such excess business interest expense. The fair market value of UTP
EBIE, described in the preceding sentence, is not adjusted by any
revaluations occurring under Sec. 1.704-1(b)(2)(iv)(f).
In addition to generally treating UTP EBIE as having a basis
component in excess of fair market value and, thus, built-in loss
property, proposed Sec. 1.163(j)-6(j)(4) would also provide that
upper-tier partnership shall also treat UTP EBIE as having a
carryforward component associated with it. The carryforward component
of UTP EBIE shall equal the amount of excess business interest expense
allocated from lower-tier partnership to upper-tier partnership under
Sec. 1.163(j)-6(f)(2) that is treated as such under Sec. 1.163(j)-
6(h)(2) by upper-tier partnership.
The carryforward component of UTP EBIE and the basis component of
such UTP EBIE will always be equal immediately following the allocation
of such EBIE from lower-tier partnership to upper-tier partnership if,
at the time of such allocation, upper-tier partnership was required to
reduce its section 704(b) capital account pursuant to proposed Sec.
1.163(j)-6(j)(2) due to such allocation. However, subsequent to such
initial allocation of EBIE from lower-tier partnership to upper-tier
partnership, disparities between the carryforward component of UTP EBIE
and the basis component of such UTP EBIE may arise as a result of
proposed Sec. 1.163(j)-6(j)(7).
Similar to the treatment of partner basis items (which do not
affect the ATI of a partnership), proposed Sec. 1.163(j)-6(j)(7)(i)
would provide that negative basis adjustments under sections 734(b) and
743(b) allocated to UTP EBIE do not affect the carryforward component
of such UTP EBIE; rather, negative basis adjustments under sections
734(b) and 743(b) affect only the basis component of such UTP EBIE.
Although section 734(b) adjustments do affect a partnership's
computation of ATI, the Treasury Department and the IRS have determined
that negative section 734(b) adjustments, if allocated to UTP EBIE,
should not reduce the carryforward component of such UTP EBIE. The
purpose of proposed Sec. 1.163(j)-6(j)(7)--in addition to preventing
the duplication of loss--is to make partners indifferent for section
163(j) purposes as to whether a partner exiting upper-tier partnership
sells its interest or receives a liquidating distribution from upper-
tier partnership. Excluding negative section 734(b) adjustments from
proposed Sec. 1.163(j)-6(j)(7) would frustrate this purpose.
3. UTP EBIE Conversion Events
Proposed Sec. 1.163(j)-6(j)(4) would further provide that if an
allocation of excess business interest expense from lower-tier
partnership is treated as UTP EBIE of upper-tier partnership, upper-
tier partnership shall treat such allocation of excess business
interest expense from lower-tier partnership as UTP EBIE until the
occurrence of an UTP EBIE conversion event described in proposed Sec.
1.163(j)-6(j)(5). In the non-tiered context, EBIE generally has two
types of conversion events. The first EBIE conversion event is when
EBIE is
[[Page 56858]]
treated as BIE paid or accrued pursuant to Sec. 1.163(j)-6(g). The
second EBIE conversion event is the basis addback that occurs pursuant
to proposed Sec. 1.163(j)-6(h)(3) when a partner disposes of its
interest in a partnership. Proposed Sec. 1.163(j)-6(j)(5)(i) and (ii),
respectively, would provide guidance regarding these two types of
conversion events in the tiered partnership context.
a. First Type of Conversion Event--UTP EBIE Treated as Paid or Accrued
Regarding the first type of conversion event, proposed Sec.
1.163(j)-6(j)(5)(i) would provide that to the extent upper-tier
partnership is allocated excess taxable income (or excess business
interest income) from lower-tier partnership, or Sec. 1.163(j)-6
(m)(3) applies, upper-tier partnership shall apply proposed Sec.
1.163(j)-6(j)(5)(i)(A) through (C).
First, proposed Sec. 1.163(j)-6(j)(5)(i)(A) requires upper-tier
partnership to apply the rules in Sec. 1.163(j)-6(g) to its UTP EBIE,
using any reasonable method (including, for example, FIFO and LIFO) to
determine which UTP EBIE is treated as business interest expense paid
or accrued pursuant Sec. 1.163(j)-6(g). If Sec. 1.163(j)-6(m)(3)
applies, upper-tier partnership shall treat all of its UTP EBIE from
lower-tier partnership as paid or accrued.
Proposed Sec. 1.163(j)-6(j)(5)(i)(A) would provide that upper-tier
partnership must determine which of its UTP EBIE is treated as paid or
accrued, as opposed to just providing that upper-tier partnership
reduces its UTP EBIE, because UTP EBIE is not necessarily a unified tax
attribute of upper-tier partnership. UTP EBIE of upper-tier partnership
could have been allocated in different years, have different bases, and
have different specified partners (defined in the next paragraph). For
example, assume $30 of UTP EBIE was allocated a negative $10 section
734(b) adjustment, resulting in the aggregate of upper-tier
partnership's UTP EBIE having a carryforward component of $30 and basis
component of $20. Thus, such UTP EBIE could, at most, result in $20 of
deduction (the basis of such UTP EBIE). However, upper-tier partnership
does not necessarily need $100 of ETI (or $30 of EBII) to deduct such
$20. Rather, if upper-tier partnership was allocated $20 of EBII,
upper-tier partnership could deduct $20 of business interest expense
if, using a reasonable method, it determined the $20 of UTP EBIE with
full basis was the UTP EBIE treated as business interest expense paid
or accrued pursuant to Sec. 1.163(j)-6(j)(5)(i)(A). Following such
treatment, upper-tier partnership would still have $10 of UTP EBIE with
$0 basis remaining (that is, $10 of carryforward component and $0 of
basis component).
Second, with respect to any UTP EBIE treated as business interest
expense paid or accrued in proposed Sec. 1.163(j)-6(j)(5)(i)(A),
proposed Sec. 1.163(j)-6(j)(5)(i)(B) would require upper-tier
partnership to allocate any business interest expense that was formerly
such UTP EBIE to its specified partner. For purposes of proposed Sec.
1.163(j)-6(j), the term specified partner refers to the partner of
upper-tier partnership that, due to the initial allocation of excess
business interest expense from lower-tier partnership to upper-tier
partnership, was required to reduce its section 704(b) capital account
pursuant to proposed Sec. 1.163(j)-6(j)(2). Similar principles apply
if the specified partner of such business interest expense is itself a
partnership.
Proposed Sec. 1.163(j)-6(j)(6) would provide rules if a specified
partner disposes of its interest. Specifically, proposed Sec.
1.163(j)-6(j)(6)(i) would provide that if a specified partner
(transferor) disposes of an upper-tier partnership interest (or an
interest in a partnership that itself is a specified partner), the
portion of any UTP EBIE to which the transferor's status as specified
partner relates is not reduced pursuant to proposed Sec. 1.163(j)-
6(j)(5)(ii). Stated otherwise, if a partner of an upper-tier
partnership disposes of its interest in the upper-tier partnership, an
interest in the lower-tier partnership held by upper-tier partnership
is not deemed to have been similarly disposed of for purposes of
proposed Sec. 1.163(j)-6(j)(5)(ii). See Rev. Rul. 87-115. Rather, such
UTP EBIE attributable to the interest disposed of is retained by upper-
tier partnership and the transferee is treated as the specified partner
for purposes of proposed Sec. 1.163(j)-6(j) with respect to such UTP
EBIE. Thus, upper-tier partnership must allocate any business interest
expense that was formerly such UTP EBIE to the transferee.
Additionally, proposed Sec. 1.163(j)-6(j)(6)(ii) would provide
special rules regarding the specified partner of UTP EBIE following
certain nonrecognition transactions. Proposed Sec. 1.163(j)-
6(j)(6)(ii)(A) would provide that if a specified partner receives a
distribution of property in complete liquidation of an upper-tier
partnership interest, the portion of UTP EBIE of upper-tier partnership
attributable to the liquidated interest shall not have a specified
partner. If a specified partner (transferee) receives a distribution of
an interest in upper-tier partnership in complete liquidation of a
partnership interest, the transferee is the specified partner with
respect to UTP EBIE of upper-tier partnership only to the same extent
it was prior to the distribution. Similar principles apply where an
interest in a partnership that is a specified partner is distributed in
complete liquidation of a transferee's partnership interest.
Proposed Sec. 1.163(j)-6(j)(6)(ii)(B) would further provide that
if a specified partner (transferor) contributes an upper-tier
partnership interest to a partnership (transferee), the transferee is
treated as the specified partner for purposes of proposed Sec.
1.163(j)-6(j) with respect to the portion of the UTP EBIE attributable
to the contributed interest. Following the transaction, the transferor
continues to be the specified partner with respect to the UTP EBIE
attributable to the contributed interest. Similar principles apply
where an interest in a partnership that is a specified partner is
contributed to a partnership.
Finally, after determining the specified partner of the UTP EBIE
treated as business interest expense paid or accrued in proposed Sec.
1.163(j)-6(j)(5)(i)(A) and allocating such business interest expense to
its specified partner pursuant to proposed Sec. 1.163(j)-
6(j)(5)(i)(B), proposed Sec. 1.163(j)-6(j)(5)(i)(C) would require
upper-tier partnership to, in the manner provided in proposed Sec.
1.163(j)-6(j)(7)(ii) (or (iii), as the case may be), take into account
any negative basis adjustments under section 734(b) previously made to
the UTP EBIE treated as business interest expense paid or accrued in
(A) earlier. Additionally, persons treated as specified partners with
respect to the UTP EBIE treated as business interest expense paid or
accrued in (A) earlier shall take any negative basis adjustments under
section 743(b) into account in the manner provided in proposed Sec.
1.163(j)-6(j)(7)(ii) (or (iii), as the case may be).
Proposed Sec. 1.163(j)-6(j)(7)(ii) would provide that if UTP EBIE
that was allocated a negative section 734(b) adjustment is subsequently
treated as deductible business interest expense, then such deductible
business interest expense does not result in a deduction to the upper-
tier partnership or the specified partner of such deductible business
interest expense. If UTP EBIE that was allocated a negative section
743(b) adjustment is subsequently treated as deductible business
interest expense, the specified partner of such deductible business
interest expense recovers any negative section 743(b) adjustment
attributable to such deductible business interest expense
[[Page 56859]]
(effectively eliminating any deduction for such deductible business
interest expense).
Proposed Sec. 1.163(j)-6(j)(7)(iii) would provide that if UTP EBIE
that was allocated a negative section 734(b) or 743(b) adjustment is
subsequently treated as excess business interest expense, the specified
partner's basis decrease in its upper-tier partnership interest
required under proposed Sec. 1.163(j)-6(h)(2) is reduced by the amount
of the negative section 734(b) or 743(b) adjustment previously made to
such excess business interest expense. If such excess business interest
expense is subsequently treated as business interest expense paid or
accrued by the specified partner, no deduction shall be allowed for any
of such business interest expense. If the specified partner of such
excess business interest expense is a partnership, such excess business
interest expense is considered UTP EBIE that was previously allocated a
negative section 734(b) adjustment for purposes of proposed Sec.
1.163(j)-6(j).
b. Second Type of Conversion Event--UTP EBIE Reduction
Regarding the second type of conversion event, proposed Sec.
1.163(j)-6(j)(5)(ii) would provide that if upper-tier partnership
disposes of a lower-tier partnership interest (transferred interest),
upper-tier partnership shall apply proposed Sec. 1.163(j)-
6(j)(5)(ii)(A) through (C).
First, proposed Sec. 1.163(j)-6(j)(5)(ii)(A) would require upper-
tier partnership to apply the rules in Sec. 1.163(j)-6(h)(3) (except
as provided in (B) and (C) later), using any reasonable method
(including, for example, FIFO and LIFO) to determine which UTP EBIE is
reduced pursuant to Sec. 1.163(j)-6(h)(3). Stated otherwise, proposed
Sec. 1.163(j)-6(j)(5)(ii)(A) would require upper-tier partnership to
apply all of the rules in Sec. 1.163(j)-6(h)(3), except for the rule
that determines the amount of the basis increase immediately before the
disposition to the disposed of interest (the first sentence of Sec.
1.163(j)-6(h)(3)). In lieu of applying the first sentence of Sec.
1.163(j)-6(h)(3), upper-tier partnership would apply proposed Sec.
1.163(j)-6(j)(5)(ii)(B) and (C) to determine the amount of such basis
increase.
Second, proposed Sec. 1.163(j)-6(j)(5)(ii)(B) would require upper-
tier partnership to increase the adjusted basis of the transferred
interest immediately before the disposition by the total amount of the
UTP EBIE that was reduced in (A) earlier (the amount of UTP EBIE
proportionate to the transferred interest). For example, if upper-tier
partnership disposed of half of its lower-tier partnership interest
while it held $40 of UTP EBIE allocated from lower tier partnership,
upper-tier partnership would increase the adjusted basis of the
disposed of lower-tier partnership interest by $20. However,
immediately before the disposition, such $20 increase may be reduced
pursuant to proposed Sec. 1.163(j)-6(j)(5)(ii)(C).
Third, proposed Sec. 1.163(j)-6(j)(5)(ii)(C) would require upper-
tier partnership to, in the manner provided in proposed Sec. 1.163(j)-
6(j)(7)(iv), take into account any negative basis adjustments under
sections 734(b) and 743(b) previously made to the UTP EBIE that was
reduced in (A) earlier. Proposed Sec. 1.163(j)-6(j)(7)(iv) would
provide that if UTP EBIE that was allocated a negative section 734(b)
or 743(b) adjustment is reduced pursuant to proposed Sec. 1.163(j)-
6(j)(5)(ii)(A), the amount of upper-tier partnership's basis increase
under proposed Sec. 1.163(j)-6(j)(5)(ii)(B) to the disposed of lower-
tier partnership interest is reduced by the amount of the negative
section 734(b) or 743(b) adjustment previously made to such UTP EBIE.
Continuing with the previous example, assume that $5 of the $20 of
UTP EBIE reduced pursuant to proposed Sec. 1.163(j)-6(j)(5)(ii)(A) was
previously allocated a $5 negative section 743(b) adjustment. Pursuant
to proposed Sec. 1.163(j)-6(j)(5)(ii)(C), upper-tier partnership would
reduce the $20 increase it determined under proposed Sec. 1.163(j)-
6(j)(5)(ii)(B) by $5. Thus, the adjusted basis of the lower-tier
partnership interest being disposed of would be increased by $15
immediately before the disposition. Consequently, lower-tier
partnership would have a corresponding Sec. 1.163(j)-6(h)(5) basis
adjustment to its property of $15.
4. Anti-Loss Trafficking Rules
Proposed Sec. 1.163(j)-6(j) generally relies on negative sections
734(b) and 743(b) adjustments to prevent a partner from deducting
business interest expense that was formerly UTP EBIE if such partner
did not bear the economic cost of such business interest expense
payment. To the extent a negative section 734(b) or 743(b) adjustment
fails to prohibit such a deduction (or basis increase under proposed
Sec. 1.163(j)-6(j)(5)(ii)), the anti-loss trafficking rules in
proposed Sec. 1.163(j)-6(j)(8) would prohibit such a deduction (or
basis addback under proposed Sec. 1.163(j)-6(j)(5)(ii)).
The anti-loss trafficking rule under proposed Sec. 1.163(j)-
6(j)(8)(i) would prohibit the trafficking of business interest expense
by providing that no deduction shall be allowed to any transferee
specified partner for any business interest expense derived from a
transferor's share of UTP EBIE. For purposes of proposed Sec.
1.163(j)-6(j), the term transferee specified partner refers to any
specified partner that did not reduce its section 704(b) capital
account upon the initial allocation of excess business interest expense
from lower-tier partnership to upper-tier partnership pursuant to
proposed Sec. 1.163(j)-6(j)(2). However, the transferee described in
proposed Sec. 1.163(j)-6(j)(ii)(B) is not a transferee specified
partner for purposes of proposed Sec. 1.163(j)-6(j).
Proposed Sec. 1.163(j)-6(j)(8)(i) would also provide the mechanism
for disallowing such BIE. Proposed Sec. 1.163(j)-6(j)(8)(i) would
provide that if, pursuant to proposed Sec. 1.163(j)-6(j)(5)(i)(B), a
transferee specified partner is allocated business interest expense
derived from a transferor's share of UTP EBIE (business interest
expense to which the partner's status as transferee specified partner
relates), the transferee specified partner is deemed to recover a
negative section 743(b) adjustment with respect to, and in the amount
of, such business interest expense and takes such negative section
743(b) adjustment into account in the manner provided in proposed Sec.
1.163(j)-6(j)(7)(ii) (or (iii), as the case may be), regardless of
whether a section 754 election was in effect or a substantial built-in
loss existed at the time of the transfer by which the transferee
specified partner acquired the transferred interest. However, to the
extent a negative section 734(b) or 743(b) adjustment was previously
made to such business interest expense, the transferee specified
partner does not recover an additional negative section 743(b)
adjustment pursuant to this paragraph.
Additionally, the anti-loss trafficking rule under proposed Sec.
1.163(j)-6(j)(8)(ii) would prohibit the trafficking of BIE that was
formerly the UTP EBIE of a specified partner that received a
distribution in complete liquidation of its upper-tier partnership
interest. Specifically, proposed Sec. 1.163(j)-6(j)(8)(ii) would
provide that if UTP EBIE does not have a specified partner (as the
result of a transaction described in proposed Sec. 1.163(j)-
6(j)(6)(ii)(A)), upper-tier partnership shall not allocate any business
interest expense that was formerly such UTP EBIE to its partners.
Rather, for purposes of applying Sec. 1.163(j)-6(f)(2), upper-tier
partnership shall treat such business interest expense as the allocable
business interest expense (as defined in
[[Page 56860]]
Sec. 1.163(j)-6(f)(2)(ii)) of a Sec. 1.163(j)-6(j)(8)(ii) account.
Any deductible business interest expense and excess business
interest expense allocated to a Sec. 1.163(j)-6(j)(8)(ii) account at
the conclusion of the eleven-step computation set forth in Sec.
1.163(j)-6(f)(2) is not tracked in future years. Treating such business
interest expense as the allocable business interest expense of a
separate account for purposes of applying Sec. 1.163(j)-6(f)(2)(ii)
ensures that partners of upper-tier partnership do not support a
deduction for such business interest expense (for which no deduction
will be allowed) using their shares of allocable ATI and allocable
business interest income before supporting a deduction for their own
shares of allocable business interest expense (for which a deduction
may be allowed).
Additionally, if UTP EBIE that does not have a specified partner
(as the result of a transaction described in proposed Sec. 1.163(j)-
6(j)(6)(ii)(A)) is treated as paid or accrued pursuant to Sec.
1.163(j)-6(g), upper-tier partnership shall make a Sec. 1.163(j)-
6(h)(5) basis adjustment to its property in the amount of the adjusted
basis (if any) of such UTP EBIE at the time such UTP EBIE is treated as
business interest expense paid or accrued pursuant to Sec. 1.163(j)-
6(g). The purpose of this Sec. 1.163(j)-6(h)(5) basis adjustment is to
preserve basis in the system.
Thus, any time upper-tier partnership treats UTP EBIE as business
interest expense paid or accrued pursuant to proposed Sec. 1.163(j)-
6(j)(5)(i)(A) it must apply proposed Sec. 1.163(j)-6(j)(8)(i) and
(ii). In application, upper-tier partnership would generally undertake
the following analysis when applying proposed Sec. 1.163(j)-6(j)(8)(i)
and (ii). With respect to any UTP EBIE treated as business interest
expense paid or accrued pursuant to proposed Sec. 1.163(j)-
6(j)(5)(i)(A) (UTP BIE), upper-tier partnership must first determine
whether such UTP BIE has a specified partner. If it does not have a
specified partner, upper-tier partnership must apply proposed Sec.
1.163(j)-6(j)(8)(ii), which, in general, requires upper-tier
partnership to capitalize the basis (if any) of such UTP BIE into the
basis of upper-tier partnership property via a Sec. 1.163(j)-6(h)(5)
basis adjustment.
If UTP BIE does have a specified partner, upper-tier partnership
must next determine whether the specified partner of such UTP BIE
reduced its section 704(b) capital account upon the initial allocation
of such excess business interest expense from lower-tier partnership to
upper-tier partnership pursuant to proposed Sec. 1.163(j)-6(j)(2). If
the specified partner did reduce its section 704(b) capital account
upon such initial allocation, then any deduction for such UTP BIE is
not disallowed under proposed Sec. 1.163(j)-6(j)(8)(i). However, if
the specified partner did not reduce its section 704(b) capital account
upon such initial allocation, upper-tier partnership must next
determine whether such specified partner is a transferee described in
proposed Sec. 1.163(j)-6(j)(6)(ii)(B). If it is, then any deduction
for such UTP BIE is not disallowed under proposed Sec. 1.163(j)-
6(j)(8)(i). However, if the specified partner is not a transferee
described in proposed Sec. 1.163(j)-6(j)(6)(ii)(B), then it is a
transferee specified partner, as defined in proposed Sec. 1.163(j)-
6(j)(8)(i). As a result, any deduction for such UTP BIE is disallowed
under proposed Sec. 1.163(j)-6(j)(8)(i). If there are multiple tiers
of partnerships, each tier must apply these rules.
Finally, proposed Sec. 1.163(j)-6(j)(8)(iii) would provide a
similar mechanism to proposed Sec. 1.163(j)-6(j)(8)(i) for disallowing
basis addbacks under Sec. 1.163(j)-6(h)(3) for certain UTP EBIE.
Specifically, proposed Sec. 1.163(j)-6(j)(8)(iii) would provide that
no basis increase under proposed Sec. 1.163(j)-6(j)(5)(ii) shall be
allowed to upper-tier partnership for any disallowed UTP EBIE. For
purposes of Sec. 1.163(j)-6, the term disallowed UTP EBIE refers to
any UTP EBIE that has a specified partner that is a transferee
specified partner (as defined in proposed Sec. 1.163(j)-6(j)(8)(i))
and any UTP EBIE that does not have a specified partner (as the result
of a transaction described in proposed Sec. 1.163(j)-6(j)(6)(ii)(A)).
For purposes of applying proposed Sec. 1.163(j)-6(j)(5)(ii), upper-
tier partnership shall treat any disallowed UTP EBIE in the same manner
as UTP EBIE that has previously been allocated a negative section
734(b) adjustment. However, upper-tier partnership does not treat
disallowed UTP EBIE as though it were allocated a negative section
734(b) adjustment pursuant to this paragraph to the extent a negative
section 734(b) or 743(b) adjustment was previously made to such
disallowed UTP EBIE.
5. Foundational Determinations
In general, the rules under proposed Sec. 1.163(j)-6(j) are
derived from the following three foundational determinations made by
the Treasury Department and the IRS. First, basis is preserved when
upper-tier partnership exchanges basis in its lower-tier partnership
for EBIE allocated from lower-tier partnership (UTP EBIE). Thus, upper-
tier partnership generally must treat UTP EBIE in the same manner as
built-in loss property. Second, UTP EBIE has two components--a basis
component and a carryforward component. In general, negative basis
adjustments under section 734(b) and 743(b) reduce the basis component
of UTP EBIE (and thus, any possible deduction for UTP EBIE), but do not
reduce the carryforward component of UTP EBIE; only the two conversion
events in proposed Sec. 1.163(j)-6(j)(5) are capable of reducing the
carryforward component of UTP EBIE. Third, upper-tier partnership must
allocate any business interest expense that was formerly UTP EBIE to
its specified partner--that is, the partner that reduced its section
704(b) capital account at the time of the initial allocation of the UTP
EBIE from lower-tier partnership to upper-tier partnership. If there is
a transfer of a partnership interest, the transferor generally steps
into the shoes of the transferee's status as specified partner, but may
not deduct any business interest expense derived from the transferor's
share of UTP EBIE.
The Treasury Department and the IRS request comments on this
approach. Specifically, the Treasury Department and the IRS request
comments on whether further guidance on the treatment of UTP EBIE under
the rules of subchapter K of the Code is necessary.
F. Partner Basis Adjustments Upon a Distribution
Under the 2018 Proposed Regulations, if a partner disposed of all
or substantially all of its partnership interest, the adjusted basis of
the partnership interest was increased immediately before the
disposition by the entire amount of the EBIE not previously treated as
paid or accrued by the partner. If a partner disposed of less than
substantially all of its interest in a partnership, the partner could
not increase its basis by any portion of the EBIE not previously
treated as paid or accrued by the partner. The Treasury Department and
the IRS requested comments on this approach in the preamble to the 2018
Proposed Regulations.
As discussed in the preamble to Final Regulations, commenters cited
multiple concerns with the approach adopted in the 2018 Proposed
Regulations and recommended that the Final Regulations adopt a
proportionate approach. Under such an approach, a partial disposition
of a partnership interest would trigger a proportionate EBIE basis
addback and corresponding decrease in such partner's EBIE carryover.
The Treasury
[[Page 56861]]
Department and the IRS agreed with commenters. Accordingly, Sec.
1.163(j)-6(h)(3) provides for a proportionate approach.
In general, a distribution from a partnership is either a current
distribution or a liquidating distribution; the concept of a redemptive
distribution does not exist in the partnership context. Accordingly,
proposed Sec. 1.163(j)-6(h)(4) would provide that, for purposes of
Sec. 1.163(j)-6(h)(3), a disposition includes a distribution of money
or other property by the partnership to a partner in complete
liquidation of the partner's interest in the partnership. Proposed
Sec. 1.163(j)-6(h)(4) would further provide that, for purposes of
Sec. 1.163(j)-6(h)(3), a current distribution of money or other
property by the partnership to a continuing partner is not a
disposition for purposes of Sec. 1.163(j)-6(h)(3). The Treasury
Department and the IRS request comments on whether a current
distribution of money or other property by the partnership to a
continuing partner as consideration for an interest in the partnership
should also trigger an addback and, if so, how to determine the
appropriate amount of the addback.
G. Allocable ATI and Allocable Business Interest Income of Upper-Tier
Partnership Partners
Section 1.163(j)-6(f)(2) provides an eleven-step computation
necessary for properly allocating a partnership's deductible BIE and
section 163(j) excess items among its partners. Pursuant to Sec.
1.163(j)-6(f)(2)(ii), a partnership must determine each of its
partner's allocable share of each section 163(j) item under section
704(b) and the regulations under section 704 of the Code, including any
allocations under section 704(c), other than remedial items. Further,
Sec. 1.163(j)-6(f)(2)(ii) provides that the term allocable ATI means a
partner's distributive share of the partnership's ATI (that is, a
partner's distributive share of gross income and gain items comprising
ATI less such partner's distributive share of gross loss and deduction
items comprising ATI), and the term allocable business interest income
means a partner's distributive share of the partnership's business
interest income.
In general, if a partnership is not a partner in a partnership,
each dollar of taxable income that is properly allocable to a trade or
business will have a corresponding dollar of ATI associated with it.
Accordingly, in the non-tiered partnership context, if a partner's
share of gross income and gain items comprising ATI less such partner's
share of gross loss and deduction items comprising ATI equals $1, such
partner will have $1 of allocable ATI for purposes of Sec. 1.163(j)-
6(f)(2)(ii).
However, if a partnership is a partner in a partnership, each
dollar of taxable income that is properly allocable to a trade or
business may not have a full dollar of ATI associated with it. Section
163(j)(4)(A)(ii)(I) provides that the ATI of a partner in a partnership
is determined without regard to such partner's distributive share of
any items of income, gain, deduction, or loss of such partnership.
Further, section 163(j)(4)(A)(ii)(II) provides that a partner only
increases its ATI by its distributive share of a partnership's ETI.
To illustrate, consider the following example. LTP has $100 of
income and $100 of loss properly allocable to a trade or business.
Thus, LTP has $0 of ATI. LTP specially allocates the $100 of income to
partner UTP. Under section 163(j)(4)(A)(ii)(I), UTP does not treat such
$100 of income as ATI. Additionally, UTP has $300 of income properly
allocable to a trade or business, which UTP properly treats as ATI.
Here, UTP's taxable income that is properly allocable to a trade or
business ($400) does not equal the amount of its ATI ($300).
The Treasury Department and the IRS recognize that a special rule
is necessary to coordinate situations like the one illustrated earlier
with the general requirement under Sec. 1.163(j)-6(f)(2)(ii) for
partnerships to determine a partner's allocable ATI based on such
partner's allocation of items comprising the ATI of the partnership.
Accordingly, proposed Sec. 1.163(j)-6(j)(9) would provide that, when
applying Sec. 1.163(j)-6(f)(2)(ii), an upper-tier partnership
determines the allocable ATI and allocable business interest income of
each of its partners in the manner provided in proposed Sec. 1.163(j)-
6(j)(9). Specifically, if an upper-tier partnership's net amount of tax
items that comprise (or have ever comprised) ATI is greater than or
equal to its ATI, upper-tier partnership applies the rules in paragraph
(j)(9)(ii)(A) to determine each partner's allocable ATI. However, if an
upper-tier partnership's net amount of tax items that comprise (or have
ever comprised) ATI is less than its ATI, upper-tier partnership
applies the rules in proposed Sec. 1.163(j)-6(j)(9)(ii)(B) to
determine each partner's allocable ATI. To determine each partner's
allocable business interest income, an upper-tier partnership applies
the rules in proposed Sec. 1.163(j)-6(j)(9)(iii).
H. Qualified Expenditures
The 2018 Proposed Regulations provided that partnership ATI is
reduced by deductions claimed under sections 173 (relating to
circulation expenditures), 174(a) (relating to research and
experimental expenditures), 263(c) (relating to intangible drilling and
development expenditures), 616(a) (relating to mine development
expenditures), and 617(a) (relating to mining exploration expenditures)
(collectively ``qualified expenditures''). As a result, deductions for
qualified expenditures reduced the amount of business interest expense
a partnership could potentially deduct.
A partner may elect to capitalize its distributive share of any
qualified expenditures of a partnership under section 59(e)(4)(C) or
may be required to capitalize a portion of its distributive share of
certain qualified expenditures of a partnership under section 291(b).
As a result, the taxable income reported by a partner in a taxable year
attributable to the ownership of a partnership interest may exceed the
amount of taxable income reported to the partner on a Schedule K-1.
Commenters on the 2018 Proposed Regulations recommended that a
distributive share of partnership deductions capitalized by a partner
under section 59(e) or section 291(b) increase the ATI of the partner
because qualified expenditures reduce both partnership ATI and excess
taxable income, but may not reduce the taxable income of a partner. Two
different approaches for achieving this result were suggested: (1)
Adjust the excess taxable income of the partnership, resulting in an
increase to partner ATI, and (2) increase the ATI of the partner
directly, without making any adjustments to partnership excess taxable
income.
The Treasury Department and IRS agree that a distributive share of
partnership deductions capitalized by a partner under section 59(e)
should increase the ATI of the partner and adopt the recommended
approach of increasing the ATI of the partner directly, without making
any adjustments to partnership excess taxable income. The approach of
increasing partner ATI by adjusting partnership excess taxable income
is rejected, as it would result in partnerships with more excess
taxable income than ATI--a result not possible under the current
statutory conceptual framework. The Treasury Department and IRS have
the authority to adjust ATI, but do not have a similar grant of
authority to make adjustments to partnership excess taxable income,
which is explicitly defined by statute.
Accordingly, proposed Sec. 1.163(j)-6(e)(6) would provide that the
ATI of a
[[Page 56862]]
partner is increased by the portion of such partner's allocable share
of qualified expenditures (as defined in section 59(e)(2)) to which an
election under section 59(e) applies. Any deduction allowed under
section 59(e)(1) would be taken into account in determining a partner's
ATI pursuant to Sec. 1.163(j)-1(b). Proposed Sec. 1.163(j)-
6(l)(4)(iv) would provide a similar rule in the S corporation context.
The Treasury Department and IRS are aware that a similar issue
exists in the context of depletion and request comments as to whether a
similar partner level add-back is appropriate. The Treasury Department
and IRS are also aware that a partner may be required to capitalize
certain qualified expenditures of a partnership under section 291(b)
and request comments as to whether a similar partner level add-back is
appropriate.
I. CARES Act Partnership Rules
As stated in the Background section of this preamble, section
163(j)(10), as enacted by the CARES Act, provides special rules for
partners and partnerships for taxable years beginning in 2019 or 2020.
Under sections 163(j)(10)(A)(i) and 163(j)(10)(A)(ii)(I), for
partnerships, the amount of business interest that may be deductible
under section 163(j)(1) for taxable years beginning in 2020 is computed
using the 50 percent ATI limitation. The 50 percent ATI limitation does
not apply to partnerships for taxable years beginning in 2019. See
section 163(j)(10)(A)(ii)(I). Under section 163(j)(10)(A)(iii), a
partnership may elect to not apply the 50 percent ATI limitation and,
instead, to apply the 30 percent ATI limitation. This election is made
by the partnership.
Under section 163(j)(10)(A)(ii)(II), a partner treats 50 percent of
its allocable share of a partnership's excess business interest expense
for 2019 as a business interest expense in the partner's first taxable
year beginning in 2020 that is not subject to the section 163(j)
limitation (50 percent EBIE rule). The remaining 50 percent of the
partner's allocable share of the partnership's 2019 excess business
interest expense remains subject to the section 163(j) limitation
applicable to excess business interest expense carried forward at the
partner level. A partner may elect out of the 50 percent EBIE rule.
Proposed Sec. 1.163(j)-6(g)(4) provides further guidance on the 50
percent EBIE rule.
Additionally, section 163(j)(10)(B)(i) allows a taxpayer to elect
to substitute its 2019 ATI for the taxpayer's 2020 ATI in determining
the taxpayer's section 163(j) limitation for any taxable year beginning
in 2020. Section 1.163(j)-2(b)(3) and (4) of the Final Regulations
provide general rules regarding this election. Proposed Sec. 1.163(j)-
6(d)(5) provides further guidance on this election in the partnership
context. The Treasury Department and the IRS request comments on these
proposed rules and on whether further guidance is necessary.
V. Proposed Sec. 1.163(j)-7: Application of the Section 163(j)
Limitation to Foreign Corporations and United States Shareholders
Proposed Sec. 1.163(j)-7 in these Proposed Regulations (Proposed
Sec. 1.163(j)-7) provides general rules regarding the application of
the section 163(j) limitation to foreign corporations and U.S.
shareholders of CFCs. This section V describes proposed Sec. 1.163(j)-
7 contained in the 2018 Proposed Regulations, the comments received on
proposed Sec. 1.163(j)-7 contained in the 2018 Proposed Regulations,
and Proposed Sec. 1.163(j)-7.
A. Overview of Proposed Sec. 1.163(j)-7 Contained in the 2018 Proposed
Regulations
1. General Application of Section 163(j) Limitation to Applicable CFCs
The 2018 Proposed Regulations clarify that, consistent with Sec.
1.952-2, section 163(j) and the section 163(j) regulations apply to
determine the deductibility of an applicable CFC's BIE in the same
manner as these provisions apply to determine the deductibility of a
domestic C corporation's BIE. The 2018 Proposed Regulations define an
applicable CFC as a CFC in which at least one U.S. shareholder owns
stock within the meaning of section 958(a). However, in certain cases,
the 2018 Proposed Regulations allow certain applicable CFCs to make a
CFC group election and be treated as part of a CFC group for purposes
of computing the applicable CFC's section 163(j) limitation.
2. Limitation on Amount of Business Interest Expense of a CFC Group
Member Subject to the Section 163(j) Limitation
Under the 2018 Proposed Regulations, if a CFC group election is in
effect, the amount of BIE of a CFC group member that is subject to the
section 163(j) limitation is limited to the amount of the CFC group
member's allocable share of the CFC group's applicable net BIE (which
is equal to the sum of the BIE of all CFC group members, reduced by the
BII of all CFC group members). Thus, for example, if a CFC group has no
debt other than loans between CFC group members, no portion of the BIE
of a CFC group member would be subject to the section 163(j)
limitation. A CFC group member's allocable share is computed by
multiplying the applicable net BIE of the CFC group by a fraction, the
numerator of which is the CFC group member's net BIE (computed on a
separate company basis), and the denominator of which is the sum of the
amounts of the net BIE of each CFC group member with net BIE (computed
on a separate company basis).
After applying the CFC group rules to determine each CFC group
member's allocable share of the CFC group's applicable net BIE, each
CFC group member that has BIE is required to perform a stand-alone
section 163(j) calculation to determine whether any BIE is disallowed
under the section 163(j) limitation.
3. Membership in a CFC Group
Under the 2018 Proposed Regulations, in general, a CFC group means
two or more applicable CFCs if at least 80 percent of the value of the
stock of each applicable CFC is owned, within the meaning of section
958(a), by a single U.S. shareholder or, in the aggregate, by related
U.S. shareholders that own stock of each member in the same proportion.
The 2018 Proposed Regulations also generally treat a controlled
partnership (in general, a partnership in which CFC group members own,
in the aggregate, at least 80 percent of the interests) as a CFC group
member. For purposes of identifying a CFC group, members of a
consolidated group are treated as a single person, as are individuals
filing a joint return, and stock owned by certain passthrough entities
is treated as owned proportionately by the owners or beneficiaries of
the passthrough entity.
The 2018 Proposed Regulations exclude from the definition of a CFC
group member an applicable CFC that has any income that is effectively
connected with the conduct of a trade or business in the United States.
In addition, if one or more CFC group members conduct a financial
services business, those entities are treated as comprising a separate
subgroup.
Under the 2018 Proposed Regulations, a CFC group election is made
by applying the rules applicable to CFC groups for purposes of
computing each CFC group member's deduction for BIE. Once made, the CFC
group election is irrevocable.
[[Page 56863]]
4. Roll-Up of CFC Excess Taxable Income to Other CFC Group Members and
U.S. Shareholders
Under the 2018 Proposed Regulations, if a CFC group election is in
effect with respect to a CFC group, then an upper-tier CFC group member
takes into account a proportionate share of any ``CFC excess taxable
income'' of a lower-tier CFC group member in which it directly owns
stock for purposes of computing the upper-tier member's ATI. The
meaning of the term ``CFC excess taxable income'' is analogous to the
meaning of the term ``excess taxable income'' in the context of a
partnership and S corporation, and, in general, means the amount of a
CFC group member's ATI in excess of the amount needed to prevent any
BIE of the CFC group member from being disallowed under section 163(j).
Under the 2018 Proposed Regulations, a U.S. shareholder is not
permitted to include in its ATI amounts included in gross income under
section 951(a) (subpart F inclusions), section 951A(a) (GILTI
inclusions), or section 78 (section 78 inclusions) that are properly
allocable to a non-excepted trade or business (collectively, deemed
income inclusions). However, the 2018 Proposed Regulations provide that
a portion of CFC excess taxable income of the highest-tier applicable
CFC is permitted to be used to increase the ATI of its U.S.
shareholders. That portion is equal to the U.S. shareholder's interest
in the highest-tier applicable CFC multiplied by its specified ETI
ratio. The numerator of the specified ETI ratio is the sum of the U.S.
shareholder's income inclusions under sections 951(a) and 951A(a) with
respect to the specified highest-tier member and specified lower-tier
members, and the denominator is the sum of the taxable income of the
specified highest-tier member and specified lower-tier members.
B. Summary of Comments on Proposed Sec. 1.163(j)-7 Contained in the
2018 Proposed Regulations
The Treasury Department and the IRS requested comments in the
preamble to the 2018 Proposed Regulations regarding whether it would be
appropriate to further modify the application of section 163(j) to
applicable CFCs and whether there are particular circumstances in which
it may be appropriate to exempt an applicable CFC from the application
of section 163(j). Some commenters recommended that section 163(j) not
apply to applicable CFCs. Those comments are addressed in part VIII of
the Summary of Comments and Explanation of Revisions section in the
Final Regulations.
A number of commenters broadly requested changes to the roll-up of
CFC excess taxable income. Many of these commenters expressed concern
about the administrability of rolling up CFC excess taxable income.
Some commenters suggested that the CFC group election be available to a
stand-alone applicable CFC in order to allow its CFC excess taxable
income to be used to increase the ATI of a U.S. shareholder, or that an
applicable CFC be permitted to use any CFC excess taxable income to
increase the ATI of a shareholder without regard to whether it is a CFC
group member. Furthermore, some commenters asserted that the nature of
the roll-up compels multinationals to restructure their operations in
order to move CFCs with relatively high amounts of ATI and low amounts
of interest expense to the bottom of the ownership chain and CFCs with
relatively low amounts of ATI and high amounts of interest expense to
the top of the ownership chain, in order to maximize the benefits of
the roll-up of CFC excess taxable income.
Some commenters asserted that because multinational organizations
may own hundreds of CFCs, applying the section 163(j) limitation on a
CFC-by-CFC basis, without regard to whether a CFC group election has
been made under the 2018 Proposed Regulations, represents a significant
administrative burden. Many comments suggested that CFC groups should
be permitted to apply section 163(j) on a group basis, with a single
group-level section 163(j) calculation similar to the rules applicable
to a consolidated group. A few commenters suggested that this rule
should be applied in addition to the roll-up of CFC excess taxable
income, but most commenters recommended that the group rule be applied
instead of the roll-up.
A number of commenters asserted that the requirements to be a
member of a CFC group under the 2018 Proposed Regulations are overly
restrictive. Some of these commenters recommended that the 80-percent
ownership threshold be replaced with the ownership requirements of
affiliated groups under section 1504(a), the rules of which are well-
known and understood. Others recommended that the 80-percent ownership
requirement be reduced to 50 percent, consistent with the standard for
treatment of a foreign corporation as a CFC. Still others asserted that
U.S. shareholders owning stock in applicable CFCs should not each be
required to own the same proportion of stock in each applicable CFC in
order for their ownership interests to count towards the 80-percent
ownership requirement, or that the attribution rules of section 958(b),
rather than section 958(a), should apply for purposes of determining
whether the ownership requirements are met. Finally, some of these
commenters requested that a CFC group election be permitted when one
applicable CFC meets the ownership requirements for other applicable
CFCs, even if no U.S. shareholder meets the ownership requirements for
a highest-tier applicable CFC.
Some commenters requested the CFC financial services subgroups not
be segregated from the CFC group and their BIE and BII be included in
the general CFC group.
Some commenters requested that an applicable CFC with effectively
connected income be permitted to be a member of a CFC group and that
only its effectively connected income items should be excluded.
Alternatively, commenters requested a de minimis rule that would permit
an applicable CFC to be a member of a CFC group if the applicable CFC's
effectively connected income is below a certain threshold of total
income, such as 10 percent.
Some commenters requested that the CFC group election be revocable.
The commenters proposed either making the CFC group election an annual
election or providing that the election applies for a certain period,
for example, three or five years, before it can be revoked.
Finally, commenters requested a safe harbor or exclusion providing
that if a CFC group would not be limited under section 163(j) either
because the CFC group has no net BIE or because its BIE does not exceed
30 percent of the CFC group's ATI, a U.S. shareholder would not have to
apply section 163(j) for the applicable CFC or be subject to applicable
CFC section 163(j) reporting requirements.
C. Proposed Sec. 1.163(j)-7
1. Overview
As noted in the preamble to the Final Regulations, the Treasury
Department and the IRS have determined, based on a plain reading of
section 163(j) and Sec. 1.952-2, that section 163(j) applies to
foreign corporations where relevant under current law and has applied
to such corporations since the effective date of the new provision.\1\
Congress
[[Page 56864]]
expressly provided that section 163(j) should not apply to certain
small businesses or to certain excepted trades or businesses. Nothing
in the Code or legislative history indicates that Congress intended to
except other persons with trades or businesses, as defined in section
163(j)(7), from the application of section 163(j). Accordingly, the
Treasury Department and the IRS have determined that, consistent with a
plain reading of section 163(j) and Sec. 1.952-2, it is appropriate
for section 163(j) to apply to applicable CFCs and other foreign
corporations whose taxable income is relevant for Federal tax purposes
(other than by reason of having ECI or income described in section 881
(FDAP)) (relevant foreign corporations).\2\ In the case of CFCs with
ECI, see proposed Sec. 1.163(j)-8. For further discussion of the
Treasury Department and the IRS's determination that there is not a
statutory basis for exempting applicable CFCs from the application of
section 163(j), see part VIII of the Summary of Comments and
Explanation of Revisions section of the Final Regulations.
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\1\ Section 1.952-2(b) generally provides that the taxable
income for a foreign corporation is determined by treating the
foreign corporation as a domestic corporation but with certain
enumerated exceptions. Section 1.952-2(c) provides for a number of
exceptions, but none of the exceptions affects the application of
section 163(j).
\2\ For purposes of Proposed Sec. 1.163(j)-7, the term
effectively connected income (or ECI) means income or gain that is
ECI, as defined in Sec. 1.884-1(d)(1)(iii), and deduction or loss
that is allocable to, ECI, as defined in Sec. 1.884-1(d)(1)(iii).
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A number of comments were received asserting that there are other
mechanisms that eliminate the policy need for section 163(j) to apply
to limit leverage in CFCs. For example, some commenters have cited tax
rules in foreign jurisdictions limiting interest deductions, including
thin capitalization rules (or similar rules intended to implement the
Organisation for Economic Co-operation and Development (OECD)
recommendations under Action 4 of the Base Erosion and Profits Shifting
Project). The Treasury Department and the IRS disagree with these
assertions. The Treasury Department and the IRS note that these rules
are not universally applied in other jurisdictions, that many
jurisdictions do not have any meaningful interest expense limitation
rules, and that some jurisdictions have no interest expense limitation
rules of any kind.
Even if some CFCs owned by a U.S. shareholder are in foreign
jurisdictions with meaningful thin capitalization rules, in the absence
of section 163(j), it would still be possible to use leverage to reduce
or eliminate a U.S. shareholder's global intangible low-taxed income
(GILTI) under section 951A for these CFCs. This is because for purposes
of computing a U.S. shareholder's GILTI under section 951A, tested
income of CFCs may be offset by tested losses of CFCs owned by the U.S.
shareholder. See section 951A(c). The ability to deduct interest
without limitation under section 163(j) would result in tested losses
in CFCs with significant leverage. Because of this aggregation, one
overleveraged CFC in a single jurisdiction that does not have rules
limiting interest expense can, without the application of section
163(j), reduce or eliminate tested income from all CFCs owned by a U.S.
shareholder regardless of jurisdiction.
Other comments suggested that, to the extent that debt of a CFC is
held by a related party, transfer pricing principles would discipline
the amount of interest expense. Comments also note that to the extent
that debt of a CFC is held by a third party, market forces would
discipline the leverage present in the CFC. While both of these
concepts may discipline the amount of leverage present in a CFC, they
would also discipline the amount of leverage in any entity. If Congress
believed that market forces and transfer pricing principles were
sufficient disciplines to prevent overleverage, section 163(j) would
not have been amended as part of TCJA to clearly apply to interest
expense paid or accrued to both third parties and related parties. In
addition, if transfer pricing were sufficient to police interest
expense in the related party context, old section 163(j) (as enacted in
1989 and subsequently revised prior to TCJA) would not have been
necessary.
However, the Treasury Department and the IRS also have determined
that it is appropriate, while still carrying out the provisions of the
statute and the policies of section 163(j), to reduce the
administrative and compliance burdens of applying section 163(j) to
applicable CFCs. Accordingly, Proposed Sec. 1.163(j)-7 allows for an
election to be made to apply section 163(j) on a group basis with
respect to applicable CFCs that are ``specified group members'' of a
``specified group.'' If the election is made, the specified group
members are referred to as ``CFC group members'' and all of the CFC
group members collectively are referred to as a ``CFC group.'' The
rules for determining a specified group and specified group members are
discussed in part V.C.3. of this Explanation of Provisions section. The
rules and procedures for treating specified group members as CFC group
members and for determining a CFC group are discussed in part V.C.4. of
this Explanation of Provisions section.
In addition, Proposed Sec. 1.163(j)-7 provides a safe harbor
election that exempts certain applicable CFCs from application of
section 163(j). The safe-harbor election is available for stand-alone
applicable CFCs (which is an applicable CFC that is not a specified
group member of a specified group) and CFC group members. The election
is not available for an applicable CFC that is a specified group member
but not a CFC group member because a CFC group election is not in
effect. See part V.C.7. of this Explanation of Provisions section.
Proposed Sec. 1.163(j)-7 also provides an anti-abuse rule that
increases ATI in certain circumstances.
Finally, Proposed Sec. 1.163(j)-7 allows a U.S. shareholder of a
stand-alone applicable CFC or a CFC group member of a CFC group to
include a portion of its deemed income inclusions attributable to the
applicable CFC in the U.S. shareholder's ATI. This rule does not apply
with respect to an applicable CFC that is a specified group member but
not a CFC group member because a CFC group election is not in effect.
See part V.C.9. of this Explanation of Provisions section.
The Treasury Department and the IRS anticipate that, in many
instances, Proposed Sec. 1.163(j)-7 will significantly reduce the
administrative and compliance burdens of applying section 163(j) to
applicable CFCs relative to the 2018 Proposed Regulations.
Unlike Proposed Sec. 1.163(j)-8, which provides rules for
allocating disallowed BIE to ECI and non-ECI, Proposed Sec. 1.163(j)-7
does not allocate disallowed BIE among classes of income. The Treasury
Department and the IRS request comments on appropriate methods of
allocating disallowed BIE among classes of income, such as subpart F
income, as defined in section 952, and tested income, as defined in
section 951A(c)(2)(A) and Sec. 1.951A-2(b)(1), as well as comments on
whether and the extent to which rules implementing such methods may be
necessary.
In addition, the Treasury Department and the IRS request comments
on appropriate methods of allocating disallowed BIE for other purposes,
including between items described in Sec. 1.163(j)-1(b)(22)(i) and
other items described in Sec. 1.163(j)-1(b)(22) (defining interest),
as well as comments on whether and the extent to which rules
implementing such methods may be necessary.
The Treasury Department and the IRS do not anticipate that section
163(j) will affect the tax liability of a passive foreign investment
company, within the
[[Page 56865]]
meaning of section 1297(a) (PFIC), or its shareholders, solely because
the PFIC is a relevant foreign corporation. See Sec. 1.163(j)-4(c)(1)
(providing that section 163(j) does not affect earnings and profits).
The Treasury Department and the IRS request comments on whether any
additional guidance is needed to reduce the compliance burden of
section 163(j) on PFICs and their shareholders.
2. Application of Section 163(j) to CFC Group Members
a. Single Section 163(j) Limitation for a CFC Group
Proposed Sec. 1.163(j)-7(c) provides rules for applying section
163(j) to CFC group members of a CFC group. Under the Proposed
Regulations, a single section 163(j) limitation is computed for a CFC
group. See proposed Sec. 1.163(j)-7(c)(2). For this purpose, the
current-year BIE, disallowed BIE carryforwards, BII, floor plan
financing interest expense, and ATI of a CFC group are equal to the
sums of the current-year amounts of such items for each CFC group
member for its specified taxable year with respect to the specified
period. (The terms ``specified taxable year'' and ``specified period''
are discussed in part V.C.3. of this Explanation of Provisions
section.) A CFC group member's current-year BIE, BII, floor plan
financing interest expense, and ATI for a specified taxable year are
generally determined on a separate-company basis before being included
in the CFC group calculation.
b. Allocation of CFC Group's Section 163(j) Limitation to Business
Interest Expense of CFC Group Members
The extent to which a CFC group's section 163(j) limitation is
allocated to a particular CFC group member's current-year BIE and
disallowed BIE carryforwards is determined using the rules that apply
to consolidated groups under Sec. 1.163(j)-5(a)(2) and (b)(3)(ii)
(consolidated BIE rules), subject to certain modifications. See
proposed Sec. 1.163(j)-7(c)(3)(i). Because many CFC groups will be
owned by consolidated groups, many taxpayers will be familiar with the
consolidated BIE rules.
If the sum of the CFC group's current-year BIE and disallowed BIE
carryforwards exceeds the CFC group's section 163(j) limitation, then
current-year BIE is deducted first. If the CFC group's current-year BIE
exceeds the CFC group's section 163(j) limitation, then each CFC group
member deducts the amount of its current-year BIE not in excess of the
sum of its BII and floor plan financing interest expense, if any. Then,
if the CFC group has any section 163(j) limitation remaining for the
current year, each applicable CFC with remaining current-year BIE
deducts a pro rata portion thereof.
If the CFC group's section 163(j) limitation exceeds its current-
year BIE, then CFC group members may deduct all of their current-year
BIE and may deduct disallowed BIE carryforwards not in excess of the
CFC group's remaining section 163(j) limitation. The disallowed BIE
carryforwards are deducted in the order of the taxable years in which
they arose, beginning with the earliest taxable year, and disallowed
BIE carryforwards that arose in the same taxable year are deducted on a
pro rata basis. This taxable year ordering rule is consistent with the
consolidated BIE rules. However, Proposed Sec. 1.163(j)-7 provides
special rules for disallowed BIE carryforwards when CFC group members
have different taxable years, or a CFC group member has multiple
taxable years with respect to the specified period of the CFC group.
Unlike members of a consolidated group, not all CFC group members will
have the same taxable years, and not all CFC group members will have
the same taxable year as the parent of the CFC group. As discussed in
part V.C.3 of this Explanation of Provisions section, a CFC group
member is included in a CFC group for its entire taxable year that ends
with or within a specified period.\3\
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\3\ For example, assume a U.S. multinational group parented by a
consolidated group with a taxable year that is the calendar year
includes applicable CFCs with November 30 taxable years and other
applicable CFCs with calendar year taxable years. In this case, as
discussed in more detail in part V.C.3.b. of the Explanation of
Provisions section, the specified period of the CFC group for 2020
would begin on January 1, 2020, and end on December 31, 2020.
Furthermore, the specified taxable year of a CFC group member with a
taxable year that is the calendar year is its taxable year ending
December 31, 2020, and the specified taxable year of a CFC group
member with a November 30 taxable year is its taxable year ending
November 30, 2020 (the taxable years that end with or within the
specified period). A CFC group member can also have multiple taxable
years with respect to a specified period. For example, a CFC group
member may have a short taxable year due to an election under Sec.
1.245A-5T(e)(3)(i) (elective exception to close a CFC's taxable year
in the case of an extraordinary reduction).
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c. Limitation on Pre-Group Disallowed Business Interest Expense
Carryforwards
The disallowed BIE carryforwards of a CFC group member when it
joins a CFC group (pre-group disallowed BIE carryforwards) are subject
to the same CFC group section 163(j) limitation and are deducted pro
rata with other CFC group disallowed BIE carryforwards. However, pre-
group disallowed BIE carryforwards are subject to additional
limitations, similar to the limitations on deducting the disallowed BIE
carryforwards of a consolidated group arising in a SRLY, as defined in
Sec. 1.1502-1(f), or treated as arising in a SRLY under the principles
of Sec. 1.1502-21(c) and (g). The policy of the limitation imposed on
pre-group BIE carryforwards is analogous to the policy of the SRLY
limitation for consolidated groups.
The rules and principles of Sec. 1.163(j)-5(d)(1)(B), which
applies SRLY subgroup principles to disallowed BIE carryforwards of a
consolidated group, apply to pre-group subgroups. If a CFC group member
with pre-group disallowed BIE carryforwards (loss member) leaves one
CFC group (former group) and joins another CFC group (current group),
the loss member and each other CFC group member that left the former
group and joined the current group for a specified taxable year with
respect to the same specified period consists of a ``pre-group
subgroup.'' Unlike SRLY subgroups, it is not required that all members
of a pre-group subgroup join the CFC group at the same time, since each
applicable CFC that joins a CFC group is treated as joining on the
first day of its taxable year. As a result, even if multiple applicable
CFCs are acquired on the same day in a single transaction, they would
join the CFC group on different days if they have different taxable
years.
d. Special Rules for Specified Periods Beginning in 2019 or 2020
Proposed Sec. 1.163(j)-7(c)(5) provides special rules for applying
section 163(j)(10) to CFC groups. The proposed regulations provide that
elections under section 163(j)(10) are made for a CFC group (rather
than for each CFC group member). For a specified period of a CFC group
beginning in 2019 or 2020, unless the election described in Sec.
1.163(j)-2(b)(2)(ii)(A) is made, the CFC group section 163(j)
limitation is determined by using 50 percent (rather than 30 percent)
of the CFC group's ATI for the specified period, without regard to
whether the taxable years of CFC group members begin in 2019 or 2020.
If the election described in Sec. 1.163(j)-2(b)(2)(ii)(A) is made for
a specified period of a CFC group, the CFC group section 163(j)
limitation is determined by using 30 percent (rather than 50 percent)
of the CFC group's ATI for the specified period, without regard to
whether the taxable years of CFC group members begin in 2019 or 2020.
The election is made for the CFC group by each designated U.S. person.
[[Page 56866]]
The election under Sec. 1.163(j)-2(b)(3)(i) to use 2019 ATI (that
is, ATI for the last taxable year beginning in 2019) rather than 2020
ATI (that is, ATI for a taxable year beginning in 2020) is made for a
specified period of a CFC group beginning in 2020 (2020 specified
period) and applies to the specified taxable years of CFC group members
with respect to the 2020 specified period. Accordingly, if a specified
taxable year of a CFC group member with respect to a CFC group's 2020
specified period begins in 2020, then the election is applied to such
taxable year using the CFC group member's ATI for its last taxable year
beginning in 2019. In some cases, the specified taxable year of a CFC
group member with respect to a CFC group's 2020 specified period will
begin in 2019 or 2021. If the specified taxable year of the CFC group
member begins in 2019, then the election is applied to such taxable
year using the CFC group member's ATI for its last taxable year
beginning in 2018; if the specified taxable year of the CFC group
member begins in 2021, then the election is applied to such taxable
year using the CFC group member's ATI for its last taxable year
beginning in 2020.
For example, assume a CFC group has two CFC group members, CFC1 and
CFC2, and has a specified period that is the calendar year. CFC1 has a
taxable year that is the calendar year, and CFC2 has a taxable year
that ends November 30. The election under Sec. 1.163(j)-2(b)(3)(i) is
in effect for the specified period beginning January 1, 2020, and
ending December 31, 2020 (which is the 2020 specified period). As a
result, the ATI of the CFC group for the 2020 specified period is
determined by reference to the specified taxable year of CFC1 beginning
January 1, 2019, and ending December 31, 2019 (the last taxable year
beginning in 2019), and the specified taxable year of CFC2 beginning
December 1, 2018, and ending November 30, 2019 (the last taxable year
beginning in 2018).
Alternatively, assume (i) the same CFC group instead has a 2020
specified period that begins on December 1, 2020, and ends on November
30, 2021; (ii) in 2019 and 2020, CFC1 has a taxable year that is the
calendar year, but in 2021, CFC1 has a short taxable year that begins
on January 1, 2021, and ends on June 30, 2021; and (iii) CFC2 has a
taxable year ending November 30 (for all years). Further assume that
the election under Sec. 1.163(j)-2(b)(3)(i) is in effect for the 2020
specified period. In this case, the election applies to the specified
taxable year of CFC1 that begins on January 1, 2020, and ends on
December 31, 2020; the specified taxable year of CFC1 that begins on
January 1, 2021, and ends on June 30, 2021; and the specified taxable
year of CFC2 that begins on December 1, 2020, and ends on November 30,
2021. As a result of the election, the ATI of the CFC group for the
2020 specified period is determined by reference to the specified
taxable year of CFC1 beginning January 1, 2019, and ending December 31,
2019, the specified taxable year of CFC1 beginning January 1, 2020, and
ending December 31, 2020, and the specified taxable year of CFC2
beginning December 1, 2019, and ending November 30, 2020.
If the election under Sec. 1.163(j)-2(b)(3)(i) to use 2019 ATI
rather than 2020 ATI is made for a CFC group, the CFC group's ATI for
the 2020 specified period is determined by reference to the 2019 ATI of
all CFC group members (except to the extent that 2018 or 2020 ATI is
used, as described earlier), including any CFC group member that joins
the CFC group during the 2020 specified period. Therefore, a CFC
group's ATI for the 2020 specified period may be determined by
reference to a prior taxable year of a new CFC group member even though
the CFC group member was not a CFC group member in the prior taxable
year. If a CFC group member leaves the CFC group during the 2020
specified period, the ATI of the CFC group for the 2020 specified
period is determined without regard to the ATI of the departing CFC
group member.
As stated in the Background section of this preamble, Revenue
Procedure 2020-22 generally provides the time and manner of making or
revoking elections under section 163(j)(10), including elections with
respect to applicable CFCs. References in Revenue Procedure 2020-22 to
CFC groups and CFC group members are to CFC groups and applicable CFCs
for which a CFC group election is made under the 2018 Proposed
Regulations. The rules described in this part V.C.2.d of this
Explanation of Provisions section and proposed Sec. 1.163(j)-7(c)(5)
modify the application of Revenue Procedure 2020-22 and the elections
under section 163(j)(10) for CFC groups and applicable CFCs for which a
CFC group election is made under Proposed Sec. 1.163(j)-7.
Thus, for example, if a CFC group has two designated U.S. persons
that are U.S. corporations, pursuant to proposed Sec. 1.163(j)-
7(c)(5), the election to not apply the 50 percent ATI limitation to the
CFC group for a specified period beginning in 2020 is made for the
specified period of the CFC group by each designated U.S. person, and
pursuant to Revenue Procedure 2020-22, section 6.01(2), the election to
not apply the 50 percent ATI limitation is made by the each designated
U.S. person timely filing a Federal income tax return, including
extensions, using the 30 percent ATI limitation for purposes of
determining the taxable income of the CFC group.
For purposes of applying Sec. 1.964-1(c), the elections described
in proposed Sec. 1.163(j)-7(c)(5) are treated as if made for each CFC
group member. Thus, the requirements to provide a statement and written
notice as provided under Sec. 1.964-1(c)(3)(i)(B) and (C) apply.
3. Specified Groups and Specified Group Members
a. In General
Proposed Sec. 1.163(j)-7(d) provides rules for determining a
specified group and specified group members. The determination of a
specified group and specified group members is the basis for
determining a CFC group and CFC group members. This is because a CFC
group member is a specified group member of a specified group for which
a CFC group election is in effect, and a CFC group consists of all the
CFC group members. See proposed Sec. 1.163(j)-7(e)(2).
b. Specified Group
Under proposed Sec. 1.163(j)-7(d)(2), a specified group includes
one or more chains of applicable CFCs connected through stock ownership
with a specified group parent, but only if the specified group parent
owns stock meeting the requirements of section 1504(a)(2)(B)
(pertaining to value) in at least one applicable CFC, and stock meeting
the requirements of section 1504(a)(2)(B) in each of the applicable
CFCs (except the specified group parent) is owned by one or more of the
other applicable CFCs or the specified group parent.
Unlike the general rules in section 1504, in order to avoid
breaking affiliation with a partnership or foreign trust or foreign
estate, for purposes of determining whether stock in an applicable CFC
meeting the requirements of section 1504(a)(2)(B) is owned by the
specified group parent or other applicable CFCs, proposed Sec.
1.163(j)-7(d)(2) takes into account both stock owned directly and stock
owned indirectly under section 318(a)(2)(A) through a domestic or
foreign partnership or under section 318(a)(2)(A) or (a)(2)(B) through
a foreign estate or trust (the look-through rule). For example, assume
CFC1 and CFC2 is each an applicable CFC and a
[[Page 56867]]
specified group member of a specified group. If CFC1 and CFC2 each own
50 percent of the capital and profits interests in a partnership, and
the partnership wholly owns CFC3, an applicable CFC, then, by reason of
the look-through rule, CFC3 is also included in the specified group,
although the partnership is not.
The specified group rules also differ from the affiliated group
rules in section 1504 in that they require only that 80 percent of the
total value (pursuant to section 1504(a)(2)(B)), not 80 percent of both
vote and value (pursuant to section 1504(a)(2)(A) and (a)(2)(B)), of an
applicable CFC be owned by the specified group parent or other
applicable CFCs in the specified group in order for the applicable CFC
to be included in the specified group. The Treasury Department and the
IRS determined that limiting the 80-percent threshold to value is
appropriate to prevent taxpayers from breaking affiliation by diluting
voting power below 80 percent.
The specified group has a single specified group parent, which may
be either a qualified U.S. person or an applicable CFC. However, the
specified group parent is included in the specified group only if it is
an applicable CFC. For this purpose, a qualified U.S. person means a
U.S. person that is a citizen or resident of the United States or a
domestic corporation. For purposes of determining the specified group
parent, members of a consolidated group are treated as a single
corporation and individuals whose filing status is ``married filing
jointly'' are treated as a single individual (aggregation rule). The
Treasury Department and the IRS have determined that the aggregation
rule is appropriate because all deemed inclusions with respect to
applicable CFCs included in gross income of members of a consolidated
group or of individuals filing a joint return, as applicable, are
reported on a single U.S. tax return. The Treasury Department and the
IRS determined that it is appropriate for an S corporation to be a
qualified U.S. person because an S corporation can have only a single
class of stock and therefore the economic rights of its shareholders in
all applicable CFCs owned by the S corporation are proportionate to
share ownership. On the other hand, the Treasury Department and the IRS
have determined that it is not appropriate for a domestic partnership
to be a qualified U.S. person because of the ability of partnerships to
make disproportionate or special allocations and therefore the economic
rights of partners in the partnership with respect to all applicable
CFCs owned by a partnership will not necessarily be proportionate to
ownership. However, if, for example, a domestic partnership wholly owns
an applicable CFC, which wholly owns multiple other applicable CFCs,
and no qualified U.S. person owns stock in the top-tier CFC meeting the
requirements of section 1504(a)(2)(B), taking into account the look-
through rule, then the applicable CFCs are included in a specified
group of which the top-tier CFC is the specified group parent.
The Treasury Department and the IRS request comments regarding
whether, and to what extent, the definition of a ``qualified U.S.
person'' should be expanded to include domestic estates and trusts or
whether and to what extent the look-through rule should apply if stock
of applicable CFCs is owned by domestic estates and trusts.
Each specified group has a specified period. A specified period is
similar to a taxable year but determined with respect to a specified
group. A specified group does not have a taxable year because the
specified group members may not have the same taxable year. If the
specified group parent is a qualified U.S. person, the specified period
generally ends on the last day of the taxable year of the specified
group parent and begins on the first day after the last day of the
prior specified period. Thus, for example, if the specified group
parent is a domestic corporation with a calendar year taxable year, the
specified period generally begins on January 1 and ends on December 31.
If the specified group parent is an applicable CFC, the specified
period generally ends on the last day of the required year of the
specified group parent, determined under section 898(c)(1), without
regard to section 898(c)(2), and begins on the first day after the last
day of the prior specified period. However, a specified period never
begins before the first day on which the specified group exists or ends
after the last day on which the specified group exists. Like a taxable
year, a specified period can never be longer than 12 months.
The principles of Sec. 1.1502-75(d)(1), (d)(2)(i) through
(d)(2)(ii), and (d)(3)(i) through (d)(3)(iv) (regarding when a
consolidated group remains in existence) (Sec. 1.1502-75(d)
principles) apply for purposes of determining when a specified group
ceases to exist. Solely for purposes of applying the Sec. 1.1502-75(d)
principles, each applicable CFC that is treated as a specified group
member for a taxable year of the applicable CFC with respect to a
specified period is treated as affiliated with the specified group
parent from the beginning to the end of the specified period, without
regard to the beginning or end of its taxable year. This rule does not
affect the general rule that, for purposes other than Sec. 1.1502-
75(d) (such as the application of section 163(j) to a CFC group), an
applicable CFC is a specified group member with respect to a specified
period for its taxable year ending with or within the specified
period.\4\
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\4\ For example, assume a specified group parent with a
specified period that is the calendar year acquires all of the stock
of CFC1, an applicable CFC, on June 30, Year 1, and sells all of the
stock of CFC1 on June 30, Year 3. CFC1 has a November 30 taxable
year, and the specified period is the calendar year. CFC1 is
included in the specified group on November 30, Year 1, and November
30, Year 2 (but not November 30, Year 3). As a result, CFC1 is a
specified group member for its taxable year ending November 30, Year
1, with respect to the specified period ending December 31, Year 1,
and for its taxable year ending November 30, Year 2, with respect to
the specified period ending December 31, Year 2. Solely for purposes
of applying the Sec. 1.1502-75(d) principles, CFC1 is treated as
affiliated with the specified group parent from the beginning to the
end of the specified period ending December 31, Year 1, and from the
beginning to the end of the specified period ending December 31,
Year 2. In other words, CFC1 is treated as affiliated with the
specified group parent from January 1, Year 1, to December 31, Year
2.
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The Treasury Department and the IRS request comments as to whether
any modifications to the Sec. 1.1502-75(d) principles should be made
for specified groups.
c. Specified Group Members
Proposed Sec. 1.163(j)-7(d)(3) provides rules for determining
specified group members with respect to a specified group. The
determination as to whether an applicable CFC is a specified group
member is made with respect to a taxable year of the applicable CFC and
specified period of a specified group. Specifically, if the applicable
CFC is included in a specified group on the last day of its taxable
year that ends with or within the specified period, the applicable CFC
is a specified group member with respect to the specified period for
the entire taxable year.\5\
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\5\ For example, assume CFC1, an applicable CFC, has a taxable
year beginning December 1, Year 1, and ending November 30, Year 2,
and a specified group has a specified period beginning January 1,
Year 2, and ending December 31, Year 2. If CFC1 is included in the
specified group on November 30, Year 2, then CFC1 is a specified
group member with respect to the specified period for its entire
taxable year ending November 30, Year 2. This is the case even if
CFC1 is not included in the specified group during part of its
taxable year ending November 30, Year 2 (for example, because all of
the stock of CFC2 is purchased by the specified group on June 1,
Year 2, and its taxable year does not close as a result of joining
the specified group), or if CFC1 ceases to be included in the
specified group after November 30, Year 2, but before December 31,
Year 2 (for example, because all of the stock of CFC1 is sold by the
specified group on December 15, Year 2).
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[[Page 56868]]
The Treasury Department and the IRS are concerned about the
potential for abuse that may arise if taxpayers cause an applicable CFC
that otherwise would be treated as a specified group member and a CFC
group member to avoid being treated as a CFC group member. For example,
the Treasury Department and the IRS have determined that it is not
appropriate for taxpayers to prevent an applicable CFC with high ATI
and low BIE from being part of a CFC group with a goal of increasing
its CFC excess taxable income and its U.S. shareholders' ATI
inclusions, rather than allowing the applicable CFC's ATI to be used by
the CFC group. The Treasury Department and the IRS request comments on
appropriate methods of preventing an applicable CFC from avoiding being
a CFC group member for purposes of increasing the ATI of its U.S.
shareholders. The Treasury Department and the IRS also request comments
on whether a rule similar to the rule in section 1504(a)(3), which
prevents domestic corporations from rejoining a consolidated group for
60 months, should apply to prevent applicable CFCs from rejoining a CFC
group.
4. CFC Groups and CFC Group Members
a. In General
Proposed Sec. 1.163(j)-7(e) provides rules and procedures for
treating specified group members as CFC group members and for
determining a CFC group. A CFC group member means a specified group
member of a specified group for which a CFC group election is in
effect. The specified group member is a CFC group member for a
specified taxable year with respect to a specified period. A CFC group
means all CFC group members for their specified taxable years with
respect to a specified period. See proposed Sec. 1.163(j)-7(e)(2)
(defining CFC group and CFC group member). Thus, if a CFC group
election is in place, the terms ``specified group members,'' ``CFC
group members,'' and a ``CFC group'' refer to the same applicable CFCs.
The term ``specified group,'' which is determined at any moment in
time, may not necessarily refer to the exact same applicable CFCs.
Once a CFC group election is made, the CFC group continues until
the CFC group election is revoked or until the end of the last
specified period with respect to the specified group. See proposed
Sec. 1.163(j)-7(e)(3). When a CFC group election is in effect, if an
applicable CFC becomes a specified group member with respect to a
specified period of the specified group, the CFC group election applies
to the applicable CFC and it becomes a CFC group member. When an
applicable CFC ceases to be a specified group member with respect to a
specified period of a specified group, the CFC group election
terminates solely with respect to the applicable CFC. See proposed
Sec. 1.163(j)-7(e)(4) (joining or leaving a CFC group).
b. Making or Revoking a CFC Group Election
Proposed Sec. 1.163(j)-7(e)(5) provides rules for making and
revoking a CFC group election. Proposed Sec. 1.163(j)-7(e)(5)(i)
provides that a CFC group election applies with respect to a specified
period of a specified group. Accordingly, the CFC group election
applies to each specified group member for its entire specified taxable
year that ends with or within the specified period. In response to
comments to the 2018 Proposed Regulations, the CFC group election is
not irrevocable. Instead, once made, a CFC group election cannot be
revoked with respect to any specified period of the specified group
that begins during the 60-month period following the last day of the
first specified period for which the election was made. Similarly, once
revoked, a CFC group election cannot be made again with respect to any
specified period of the specified group that begins during the 60-month
period following the last day of the first specified period for which
the election was revoked.
The Treasury Department and the IRS request comments regarding
whether a specified group that does not make a CFC group election when
it first comes into existence (or for the first specified period
following 60 days after the date of publication of the Treasury
decision adopting these regulations as final in the Federal Register)
should be prohibited from making the CFC group election for any
specified period beginning during the 60-month period following that
specified period.
Thus, under the Proposed Regulations, in the case of a specified
group, taxpayers choose to apply section 163(j) to specified group
members on a CFC group basis or on a stand-alone basis for no less than
a 60-month period. The Treasury Department and the IRS have determined
that a 60-month period is an appropriate balance between making the
choice irrevocable and providing an annual election, the latter of
which may facilitate inappropriate tax planning (in this regard, see,
for example, the discussion in part C.7 of this part V of the
Explanation of Provisions section).
c. Specified Financial Services Subgroup Rules
In response to comments, Proposed Sec. 1.163(j)-7 does not provide
for CFC financial services subgroups. Instead, applicable CFCs that
otherwise qualify as CFC group members are treated as part of the same
CFC group.
d. Interaction of the CFC Group Election in Proposed Sec. 1.163(j)-7
With the CFC Group Election in the 2018 Proposed Regulations
The CFC group election can be made only in accordance with the
method prescribed in proposed Sec. 1.163(j)-7(e)(5). The 2018 Proposed
Regulations also contained an election called a ``CFC group election''
(old CFC group election). The old CFC group election is a different
election than the CFC group election contained in Proposed Sec.
1.163(j)-7. Accordingly, the old CFC group election may be relied on
only for taxable years in which the taxpayer relies on the 2018
Proposed Regulations. Whether an old CFC group election was made under
the 2018 Proposed Regulations has no effect on whether a CFC group
election under proposed Sec. 1.163(j)-7(e)(5) is in effect for any
taxable year in which the taxpayer relies on Proposed Sec. 1.163(j)-7.
5. Exclusion of ECI From Application of Section 163(j) to a CFC Group
In response to comments, proposed Sec. 1.163(j)-7 provides that an
applicable CFC with ECI is not precluded from being a CFC group member.
However, under proposed Sec. 1.163(j)-7(f), only the ATI, BII, BIE,
and floor plan financing of the applicable CFC that are not
attributable to ECI are included in the CFC group's section 163(j)
calculations. The ECI items of the applicable CFC are not included in
the CFC group calculations. Instead, the ECI of the applicable CFC is
treated as income of a separate CFC, an ``ECI deemed corporation,''
that has the same taxable year and shareholders as the applicable CFC,
but that is not a CFC group member. The ECI deemed corporation must do
a separate section 163(j) calculation for its ECI in accordance with
Proposed Sec. 1.163(j)-8. See Proposed Sec. 1.163(j)-8 and part VI of
this Explanation of Provisions section for rules applicable to foreign
corporations with ECI.
6. Treatment of Foreign Taxes for Purposes of Computing ATI
Proposed Sec. 1.163(j)-7(g)(3) provides that, for purposes of
computing its ATI, tentative taxable income of a relevant foreign
corporation is determined by taking into account a deduction for
[[Page 56869]]
foreign taxes. This rule is consistent with Sec. 1.952-2, which
provides that the taxable income of a foreign corporation for any
taxable year is determined by treating the foreign corporation as a
domestic corporation, and section 164(a), which allows a deduction for
foreign taxes. The Treasury Department and the IRS request comments
regarding whether, and the extent to which, the ATI of a relevant
foreign corporation should be determined by adding to tentative taxable
income any deductions for foreign income taxes.
7. Anti-Abuse Rule
The Treasury Department and the IRS are concerned that, in certain
situations, U.S. shareholders may inappropriately affirmatively plan to
limit BIE deductions as part of a tax-planning transaction, including
by not making a CFC group election for purposes of increasing the
disallowed BIE of a specified group member or of a partnership
substantially owned by specified group members of the same specified
group. For example, in a taxable year in which a U.S. shareholder would
otherwise have foreign tax credits in the section 951A category in
excess of the section 904 limitation, a U.S. shareholder might
inappropriately cause one specified group member to pay interest to
another specified group member in an amount in excess of the borrowing
specified group member's section 163(j) limitation. As a result, the
U.S. shareholder's pro rata share of tested income of the borrowing
specified group member for the taxable year would be increased without
increasing the U.S. shareholder's Federal income tax because excess
foreign tax credits in the section 951A category in the taxable year
that cannot be carried forward to a future taxable year would offset
the Federal income tax on the incremental increase in the U.S.
shareholder's pro rata share of tested income, while also enabling the
borrowing specified group member to generate a disallowed BIE
carryforward that may be used in a subsequent taxable year.
Accordingly, under proposed Sec. 1.163(j)-7(g)(4), if certain
conditions are met, when one specified group member or applicable
partnership (specified borrower) pays interest to another specified
group member or applicable partnership (specified lender), and the
payment is BIE to the specified borrower and income to the specified
lender, then the ATI of the specified borrower is increased by the
amount necessary such that the BIE of the specified borrower is not
limited under section 163(j). This amount is determined by multiplying
the lesser of the payment amount or the disallowed BIE (computed
without regard to this ATI adjustment) by 3\1/3\ (or by 2, in the case
of taxable years or specified taxable years with respect to a specified
period for which the section 163(j) limitation is determined by
reference to 50 percent of ATI). A partnership is an applicable
partnership if at least 80 percent of the capital or profits interests
is owned, in aggregate, by direct or direct partners that are specified
group members of the same specified group. The conditions for this rule
to apply are as follows: (i) The BIE is incurred with a principal
purpose of reducing the Federal income tax liability of a U.S.
shareholder (including over multiple taxable years); (ii) the effect of
the specified borrower treating the payment amount as disallowed BIE
would be to reduce the Federal income tax of a U.S. shareholder; and
(iii) either no CFC group election is in effect or the specified
borrower is an applicable partnership.
8. The Safe-Harbor Election
Proposed Sec. 1.163(j)-7(h) provides a safe-harbor election for
stand-alone applicable CFCs and CFC groups. If the safe-harbor election
is in effect for a taxable year, no portion of the BIE of the stand-
alone applicable CFC or of each CFC group member, as applicable, is
disallowed under the section 163(j) limitation. The safe-harbor
election is an annual election. If the election is made, then no
portion of any CFC excess taxable income is included in a U.S.
shareholder's ATI. See proposed Sec. 1.163(j)-7(j)(2)(iv).
The safe-harbor election cannot be made with respect to any foreign
corporation that is not a stand-alone applicable CFC or a CFC group
member. As a result, if a CFC group election is not in effect for a
specified period, a specified group member of the specified group is
not eligible for the safe-harbor election.
In the case of a stand-alone applicable CFC, the safe-harbor
election may be made for a taxable year of the stand-alone applicable
CFC if its BIE does not exceed 30 percent of the lesser of (i) its
tentative taxable income attributable to non-excepted trades or
businesses (referred to as ``qualified tentative taxable income''), and
(ii) its ``eligible amount'' for the taxable year. In the case of a CFC
group, the safe-harbor election may be made for the specified taxable
years of each CFC group member with respect to a specified period if
the CFC group's BIE does not exceed 30 percent of the lesser of (i) the
sum of the qualified tentative taxable income of each CFC group member,
and (ii) the sum of the eligible amounts of each CFC group member. For
taxable years of a stand-alone applicable CFC or specified periods of a
CFC group beginning in 2019 or 2020, the 30 percent limitation is
replaced with a 50 percent limitation, consistent with the change in
the section 163(j) limitation to take into account 50 percent, rather
than 30 percent, of ATI for such taxable years or specified periods.
The ``eligible amount'' is a CFC-level determination. In general,
the eligible amount is the sum of the applicable CFC's subpart F income
plus the approximate amount of GILTI inclusions its U.S. shareholders
would have were the applicable CFC wholly owned by domestic
corporations that had no tested losses and that were not subject to the
section 250(a)(2) limitation on the section 250(a)(1) deduction.
Amounts used in the determination of the eligible amount are computed
without regard to the application of section 163(j) and the section
163(j) regulations. While the eligible amount of an applicable CFC
cannot be negative, qualified tentative taxable income can be negative.
Thus, limiting the safe-harbor to 30 percent of qualified tentative
taxable income ensures that losses of a stand-alone applicable CFC or a
CFC group are taken into account in determining whether the stand-alone
applicable CFC or the CFC group qualifies for the safe-harbor.\6\
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\6\ For example, assume that, before taking into account BIE, a
stand-alone applicable CFC has net income of $0x, consisting of
$100x of subpart F income, a $100x loss attributable to foreign oil
and gas extraction income, as defined in section 907(c)(1). It also
has $20x of BIE, no BII, and no floor plan financing interest
expense. The ATI of the CFC is zero and the section 163(j)
limitation would be zero. However, the eligible amount of the CFC is
$100x. Thus, absent a rule limiting the safe harbor to 30 percent of
qualified tentative taxable income, the CFC would be permitted to
deduct its $20x of business interest expense under the safe harbor,
even though none of the BIE would be deductible under the section
163(j) limitation.
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The safe-harbor election does not apply to EBIE, as described in
Sec. 1.163(j)-6(f)(2), and EBIE is not taken into account for purposes
of determining whether the safe-harbor election is available for a
stand-alone applicable CFC or a CFC group, until such business interest
expense is treated as paid or accrued by an applicable CFC in a
succeeding year (that is, until the applicable CFC is allocated excess
taxable income or excess business interest income from such partnership
in accordance with Sec. 1.163(j)-6(g)(2)(i)).
The safe-harbor election is intended to reduce the compliance
burden on applicable CFCs that would not have disallowed BIE if they
applied the
[[Page 56870]]
section 163(j) calculation. However, the Treasury Department and the
IRS are concerned that the safe-harbor election might be used to deduct
pre-group disallowed BIE carryforwards that would be limited under
proposed Sec. 1.163(j)-7(c)(3)(iv) (rules similar to the consolidated
SRLY rules). Accordingly, the proposed regulations provide that a safe-
harbor election cannot be made for a CFC group that has pre-group
disallowed BIE carryforward. The Treasury Department and the IRS
request comments on whether the safe-harbor election should be
available for CFC groups with pre-group disallowed BIE carryforwards
and, if so, appropriate methods of preventing pre-group disallowed BIE
carryforwards that would be limited under proposed Sec. 1.163(j)-
7(c)(3)(iv) from being deductible by CFC group members of CFC groups
that apply the safe-harbor election.
The Treasury Department and the IRS also request comments on
appropriate modifications, if any, to the safe-harbor election that
would further the goal of reducing the compliance burden on stand-alone
applicable CFCs and CFC groups that would not have disallowed BIE if
they applied the section 163(j) limitation.
9. Increase in Adjusted Taxable Income of U.S. Shareholders
As a general matter, a U.S. shareholder does not include in its ATI
any portion of its specified deemed inclusions. Specified deemed
inclusions include the U.S. shareholder's deemed income inclusions
attributable to an applicable CFC and a non-excepted trade or business
of the U.S. shareholder. See Sec. 1.163(j)-1(b)(2)(ii)(G). Specified
deemed inclusions also include amounts included in a domestic C
corporation's allocable share of a domestic partnership's gross income
inclusions under sections 951(a) and 951A(a) with respect to an
applicable CFC that are investment income to the partnership, to the
extent that such amounts are treated as properly allocable to a non-
excepted trade or business of the domestic C corporation under
Sec. Sec. 1.163(j)-4(b)(3) and 1.163(j)-10.\7\ However, consistent
with comments received, proposed Sec. 1.163(j)-7(j) allows a U.S.
shareholder to include in its ATI a portion of its specified deemed
inclusions that are attributable to either a stand-alone applicable CFC
or a CFC group member, except to the extent attributable to section 78
``gross-up'' inclusions. That portion is equal to the ratio of the
applicable CFC's CFC excess taxable income over its ATI.
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\7\ The Treasury Department and the IRS anticipate that a
domestic partnership's gross income inclusions under sections 951(a)
and 951A(a) will virtually always be investment income to the
partnership. See section 163(j)(5), excluding ``investment
interest'' subject to section 163(d) from the definition of business
interest, and sections 163(d)(3)(A) and (d)(5), treating as
investment interest any interest properly allocable to ``property
which produces income of a type described in section 469(e)(1).''
See also Sec. 1.469-2T(c)(3).
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In the case of a stand-alone applicable CFC, CFC excess taxable
income is equal to an amount that bears the same ratio to the
applicable CFC's ATI as (i) the excess of 30 percent of the applicable
CFC's ATI over the amount, if any, by which its BIE exceeds its BII and
floor plan financing interest expense, bears to (ii) 30 percent of its
ATI. In the case of a CFC group, each applicable CFC's CFC excess
taxable income is determined by calculating the excess taxable income
of the CFC group and allocating it to each CFC group member pro rata on
the basis of the CFC group member's ATI. For any taxable year or
specified period to which the 50 percent (rather than 30 percent)
limitation applies under section 163(j)(10), the formula for
calculating CFC excess taxable income is adjusted accordingly.
The Treasury Department and the IRS are concerned that taxpayers
may inappropriately attempt to aggregate debt in certain specified
group members for which a CFC group election is not in effect, thereby
overleveraging some specified group members and artificially creating
CFC excess taxable income in other specified group members for purposes
of increasing the ATI of a U.S. shareholder.\8\ Accordingly, the
Treasury Department and the IRS have determined that any excess taxable
income of a specified group member should not become available to
increase the ATI of a U.S. shareholder unless a CFC group election is
in effect and the CFC group has not exceeded its section 163(j)
limitation. Accordingly, under proposed Sec. 1.163(j)-7(j)(4)(ii),
only U.S. shareholders of stand-alone applicable CFCs and CFC group
members can increase their ATI for a portion of their specified deemed
inclusion. To the extent that a CFC group election is not in effect, a
U.S. shareholder may not increase its ATI for any portion of its
specified deemed inclusion attributable to a specified group member of
the specified group.
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\8\ For example, assume a U.S. shareholder wholly owns CFC1,
which wholly owns CFC2. CFC1 and CFC2 each have $100x of ATI and no
business interest income or floor plan financing interest expense.
CFC1 and CFC2 have not made a CFC group election. If CFC1 and CFC2
each have $35x of business interest expense, under section 163(j),
CFC1 and CFC2 could each deduct $30x of business interest expense
and have a $5x disallowed business interest expense carryforward.
Neither CFC1 nor CFC2 would have CFC excess taxable income. As a
result, the U.S. shareholder would have no ATI inclusion from CFC1
or CFC2. However, if the CFCs move all of CFC2's debt to CFC1, CFC1
would deduct $30x of business interest expense and have a $40x
disallowed business interest expense carryforward. Absent rules
providing otherwise, CFC2 would have $100x of CFC excess taxable
income and $100x of ATI, allowing the U.S. shareholder to include in
its ATI its CFC income inclusion attributable to CFC2 (to the extent
attributable to a non-excepted trade or business and not
attributable to section 78 ``gross-up'' inclusions).
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In addition, if a safe-harbor election is in effect with respect to
the taxable year of a stand-alone applicable CFC or the specified
period of a CFC group, CFC excess taxable income is not calculated for
the stand-alone applicable CFC or the CFC group members. As a result,
proposed Sec. 1.163(j)-7(j)(4)(i) provides that a U.S. shareholder of
a stand-alone applicable CFC or of a CFC group member for which the
safe-harbor election is in effect does not increase its ATI for any
portion of its specified deemed inclusion attributable to the stand-
alone applicable CFC or CFC group member.
VI. Section 1.163(j)-8: Application of the Business Interest Deduction
Limitation to Foreign Persons With Effectively Connected Income
A. Proposed Sec. 1.163(j)-8 Contained in the 2018 Proposed Regulations
The 2018 Proposed Regulations under Sec. 1.163(j)-8 provide rules
for how section 163(j) applies to a nonresident alien individual or
foreign corporation that is not an applicable CFC (specified foreign
person) with ECI. Although the regulations under section 163(j)
generally apply to specified foreign persons, a number of the general
rules under section 163(j) need to be adjusted to take into account the
fact that a specified foreign person is taxed only on its ECI rather
than all of its income. Accordingly, the definitions for ATI, BIE, BII,
and floor plan financing interest expense are modified to limit such
amounts to items that are, or are allocable to, ECI. The 2018 Proposed
Regulations also modify Sec. 1.163(j)-10(c) to provide that a
specified foreign person's interest expense and interest income are
only allocable to excepted or non-excepted trades or businesses that
have ECI.
Under the 2018 Proposed Regulations, a specified foreign person
that is a partner in a partnership that has ECI (specified foreign
partner) is required to modify the application of the general
allocation rules in Sec. 1.163(j)-6 with respect to ETI, EBIE, and
EBII of the
[[Page 56871]]
partnership to take into account only the partnership's items that are,
or are allocable to, ECI. Although the section 163(j) limitation is
determined on an entity basis by a partnership, the Treasury Department
and the IRS determined that excess items of a partnership should only
be used by the specified foreign partner to the extent that the excess
items arise from partnership items that are ECI with respect to the
specified foreign partner. The amount of ETI and EBIE to be used by a
specified foreign partner was determined by multiplying the amount of
the ETI or the EBIE allocated under Sec. 1.163(j)-6 to the specified
foreign partner by a fraction, the numerator of which is the ATI of the
partnership, with the adjustments described previously to limit such
amount to only items that are ECI, and the denominator of which is the
ATI of the partnership determined under Sec. 1.163(j)-6(d). The amount
of EBII that could be used by a specified foreign partner was limited
to the amount of allocable BII that is ECI from the partnership that
exceeds allocable BIE that is allocable to income that is ECI from the
partnership.
Lastly, the 2018 Proposed Regulations provide that an applicable
CFC that has ECI must first apply the general rules of section 163(j)
and the section 163(j) regulations to determine how section 163(j)
applies to the applicable CFC. If the applicable CFC has disallowed
BIE, the applicable CFC then must apportion a part of its disallowed
BIE to BIE allocable to income that is ECI. The amount of disallowed
BIE allocable to income that is ECI is equal to the disallowed BIE
multiplied by a fraction, the numerator of which is the applicable
CFC's ECI ATI, and the denominator of which is the CFC's ATI.
No comments were received on the 2018 Proposed Regulations under
Sec. 1.163(j)-8. Nonetheless, the Treasury Department and the IRS have
become aware of certain distortions that can result under the 2018
Proposed Regulations. Accordingly, proposed Sec. 1.163(j)-8 has been
revised, and re-proposed, to alleviate these distortions and to provide
additional guidance and clarity on the manner in which these rules
apply to specified foreign partners and CFCs with ECI.
B. Proposed Sec. 1.163(j)-8 in the Proposed Regulations
Proposed Sec. 1.163(j)-8 in the Proposed Regulations (Proposed
Sec. 1.163(j)-8) provides rules concerning the application of section
163(j) to foreign persons with ECI.\9\ Similar to proposed Sec.
1.163(j)-8(b) in the 2018 Proposed Regulations, proposed Sec.
1.163(j)-8(b)(1)-(5) provides that, for purposes of applying section
163(j) and the section 163(j) regulations to a specified foreign
person, certain definitions (ATI, BIE, BII, and floor plan financing
interest expense) are modified to take into account only ECI items.
Additionally, proposed Sec. 1.163(j)-8(b)(6) provides that, for
purposes of applying Sec. 1.163(j)-10(c) to a specified foreign
person, only ECI items and assets that are U.S. assets are taken into
account in determining the amount of interest income and interest
expense allocable to a trade or business.
---------------------------------------------------------------------------
\9\ For purposes of Proposed Sec. 1.163(j)-8, the term
effectively connected income (or ECI) means income or gain that is
ECI, as defined in Sec. 1.884-1(d)(1)(iii), and deduction or loss
that is allocable to, ECI, as defined in Sec. 1.884-1(d)(1)(iii).
---------------------------------------------------------------------------
Proposed Sec. 1.163(j)-8(c) determines the portion of a specified
foreign partner's allocable share of ETI, EBIE, and EBII (as determined
under Sec. 1.163(j)-6) that is treated as ECI and the portion that is
not treated as ECI. The portion of the specified foreign partner's
allocable share of ETI that is ECI is equal to its allocable share of
ETI multiplied by a fraction, the specified ATI ratio (which compares
the specified foreign partner's distributive share of the partnership's
ECI to its distributive share of the partnership's total income). The
remainder of the specified foreign partner's allocable share of ETI is
not ECI. See proposed Sec. 1.163(j)-8(c)(1). Similar to ETI, the
portion of the specified foreign partner's allocable share of EBII that
is ECI is equal to its allocable share of EBII multiplied by a
fraction, the specified BII ratio (which compares the specified foreign
partner's allocable share of BII that is ECI to its allocable share of
total BII). See proposed Sec. 1.163(j)-8(c)(4).
The portion of the specified foreign partner's allocable share of
EBIE that is ECI is determined by subtracting the portion of the
specified foreign partner's allocable share of deductible BIE that is
characterized as ECI from the amount of the specified foreign partner's
allocable share of BIE that is characterized as ECI. See proposed Sec.
1.163(j)-8(c)(2). A similar rule applies for purposes of determining
the portion of EBIE that is not ECI. A specified foreign partner's
allocable share of deductible BIE that is characterized as ECI or not
ECI is determined by allocating the deductible BIE pro rata between the
respective amounts of deductible BIE that the specified foreign partner
would have if the specified foreign partner's allocable share of the
ECI items of the partnership and the non-ECI items of the partnership
were treated as separate partnerships and a 163(j) limitation was
applied to each hypothetical partnership. However, no more deductible
BIE can be characterized as ECI or not ECI than the specified foreign
partner's allocable share of BIE that is ECI or the specified foreign
partner's allocable share of BIE that is not ECI, respectively. Any
deductible BIE in excess of the hypothetical partnership limitations is
characterized as ECI or not ECI pro rata in proportion to the remaining
amounts of the specified foreign partner's allocable share of BIE that
is ECI and not ECI.
Proposed Sec. 1.163(j)-8(d) determines the portion of deductible
and disallowed BIE of a relevant foreign corporation (as defined in
Sec. 1.163(j)-1(b)(33)) that is characterized as ECI or not ECI. These
rules are similar to the rules in proposed Sec. 1.163(j)-8(c) for
characterizing a specified foreign partner's allocable share of excess
items of a partnership as ECI or not ECI in that they calculate the
hypothetical section 163(j) limitation for two hypothetical foreign
corporations--a foreign corporation with ECI and a foreign corporation
with non-ECI--and allocate the deductible BIE between the two
hypothetical limitations. The portion of the relevant foreign
corporation's disallowed BIE that is ECI is determined by subtracting
the portion of the relevant foreign corporation's deductible BIE that
is characterized as ECI from the relevant foreign corporation's BIE
that is ECI. A similar rule applies for purposes of determining the
portion of disallowed BIE that is characterized as not ECI.
Proposed Sec. 1.163(j)-8(e) provides rules regarding disallowed
BIE. These rules provide that disallowed BIE is characterized as ECI or
not ECI in the year in which it arises and retains its characterization
in subsequent years. Additionally, an ordering rule determines the EBIE
that is treated as paid or accrued by a specified foreign partner in a
subsequent year. Specifically, the specified foreign partner's
allocable share of EBIE is treated as paid or accrued by the specified
foreign partner in a subsequent year pursuant to Sec. 1.163(j)-
6(g)(2)(i) in the order of the taxable years in which the allocable
EBIE arose and pro rata between the specified foreign partner's
allocable share of EBIE that is ECI and not ECI that arose in the same
taxable year.
Proposed Sec. 1.163(j)-8(e)(2) provides that, for purposes of
characterizing deductible BIE and EBIE as ECI or not ECI, a specified
foreign partner's BIE is
[[Page 56872]]
deemed to include its allocable share of EBIE of partnerships in which
it is a direct or indirect partner. As a result, EBIE of both top-tier
partnerships and lower-tier partnerships is characterized as ECI or not
ECI in the year in which it arises, even if it is not included in the
specified foreign partner's allocable share of EBIE.
Proposed Sec. 1.163(j)-8(f) provides rules coordinating the
application of section 163(j) with Sec. 1.882-5 and similar rules and
with the branch profits tax. Proposed Sec. 1.163(j)-8(f)(1)(i)
provides that a foreign corporation first determines its interest
expense on liabilities that are allocable to ECI under Sec. 1.882-5
before applying section 163(j). Similarly, interest expense, as defined
in Sec. 1.163(j)-1(b)(23), that is not allocable to ECI under Sec.
1.882-5 must be allocable to income that is ECI under the regulations
under section 861 before section 163(j) is applied.
Proposed Sec. 1.163(j)-8(f)(1)(ii) provides rules for determining
the portion of a specified foreign partner's BIE that is ECI, as
determined under Sec. 1.882-5(b) through (d) or Sec. 1.882-5(e)
(Sec. 1.882-5 interest expense), that is treated as attributable to a
partner's allocable share of interest expense of a partnership. As a
general matter, the determination as to whether a partnership's items
of income and expense are allocable to ECI is made by the partnership.
However, the determination as to the amount of interest expense that is
allocable to ECI is made by a partner, not the partnership. Because
section 163(j) applies separately to partnerships and their partners, a
determination must be made as to the source of Sec. 1.882-5 interest
expense. If the BIE is attributable to BIE of the partnership, it is
subject to the rules of Sec. Sec. 1.163(j)-6 and 1.163(j)-8(c).
The Sec. 1.882-5 interest expense is first treated as attributable
to interest expense on U.S. booked liabilities, determined under Sec.
1.882-5(d)(2)(vii), of the partner or a partnership. Any remaining
Sec. 1.882-5 interest expense (excess Sec. 1.882-5 interest expense)
is treated as attributable to interest expense on liabilities of the
partner in proportion to its U.S. assets (other than partnership
interests) over all of its U.S. assets, and as attributable to interest
expense on liabilities of the partner's direct or indirect partnership
interests in proportion to the portion of the partnership interest that
is a U.S. asset over all of the partner's U.S. assets. The total amount
of Sec. 1.882-5 interest expense attributed to the partner or a
partnership (taking into account both interest expense on U.S. booked
liabilities and excess Sec. 1.882-5 interest expense) and interest
expense on a liability described in Sec. 1.882-5(a)(1)(ii)(A) or (B)
(direct allocations) may never exceed the amount of the partner's
interest expense on liabilities or the partner's allocable share of the
partnership's interest expense on liabilities (the interest expense
limitation). The interest expense limitation prevents more Sec. 1.882-
5 interest expense from being attributed to the partner or the
partner's allocable share of interest expense of a partnership than the
actual amount of such interest expense. Any excess Sec. 1.882-5
interest expense that would have been attributed to the partner or a
partnership, but for the interest expense limitation, is re-attributed
in accordance with these attribution rules.
When excess Sec. 1.882-5 interest expense has been attributed to
all of the interest expense on liabilities of the foreign corporation
and its allocable share of partnership interests that have U.S. assets,
the remaining excess Sec. 1.882-5 interest expense, if any, is first
attributed to interest expense on liabilities of the foreign
corporation (but not in excess of the interest expense limitation), and
then, pro rata, to its allocable share of interest expense on
liabilities of its partnership interests that do not have U.S. assets,
subject to the interest expense limitation. See proposed Sec.
1.163(j)-8(f)(1)(iii). These rules merely characterize interest expense
of the foreign corporation and its partnership interests as ECI or not
ECI. These rules do not change the amount of interest expense of the
foreign corporation or its partnership interests.
The rule in proposed Sec. 1.163(j)-8(f)(1) of 2018 Proposed
Regulations providing that the disallowance and carryforwards of BIE
does not affect effectively connected earnings and profits of a foreign
corporation is not retained in Proposed Sec. 1.163(j)-8. This rule is
not necessary in Proposed Sec. 1.163(j)-8 because the general rule
regarding the effect of section 163(j) on earnings and profits in Sec.
1.163(j)-4(c)(1) applies to effectively connected earnings and profits.
VII. Proposed Sec. 1.469-9: Definition of Real Property Trade or
Business
Section 469(c)(7)(C) defines real property trade or business by
reference to eleven undefined terms. The Final Regulations amended
Sec. 1.469-9 to define two of the eleven terms--management and
operations. In response to questions received about the application of
section 469(c)(7)(C) to timberlands, these proposed regulations would
provide definitions for two additional terms--development and
redevelopment--to further clarify what constitutes a real property
trade or business.
The Treasury Department and IRS have determined that real property
development and redevelopment trades or businesses should be defined to
include business activities that involve the preservation, maintenance,
and improvement of forest-covered areas (timberland). Congress most
likely intended and expected that such business activities would be
excepted from section 163(j), through election, similar to other real
property and farming businesses. However, because timber is
specifically excluded from the definition of farming under other Code
provisions (such as section 464(e)), the Treasury Department and IRS
have determined that such business activities are more properly
described by and should be included in the definition of real property
trade or business for this purpose. These proposed regulations would
clarify that ``real property development'' is the maintenance and
improvement of raw land to make the land suitable for subdivision,
further development, or construction of residential or commercial
buildings, or to establish, cultivate, maintain or improve timberlands
(generally defined as parcels of land covered by forest). Similarly,
these proposed regulations would clarify that ``real property
redevelopment'' is the demolition, deconstruction, separation, and
removal of existing buildings, landscaping, and infrastructure on a
parcel of land to return the land to a raw condition or otherwise
prepare the land for new development or construction, or for the
establishment and cultivation of new timberlands.
VIII. Proposed Sec. 1.163(j)-2 and Sec. 1.1256(e)-2: Section 1256 and
Determination of Tax Shelter Status; Election To Use 2019 ATI To
Determine 2020 Section 163(j) Limitation
A. Section 1256 and Determination of Tax Shelter Status
Several commenters raised questions regarding the exclusion of ``a
tax shelter that is not permitted to use a cash method of accounting''
from the small business exemption provided in section 163(j)(3).
Section 448 and Sec. 1.448-1T describe limitations on the use of the
cash method of accounting, including an explicit prohibition on the use
of the cash method of accounting by a tax shelter. Section 448(d)(3)
defines a tax shelter by cross reference to section 461(i)(3), which
defines a tax shelter, in part, as a syndicate within the meaning
[[Page 56873]]
of section 1256(e)(3)(B). Under Sec. 1.448-1T(b)(3), a syndicate is
defined as an entity that is not a C corporation if more than 35
percent of the losses of such entity during the taxable year are
allocated to limited partners or limited entrepreneurs. Section
1256(e)(3)(B) refers instead to losses that are allocable to limited
partners or limited entrepreneurs. As a result, the scope of the small
business exemption in section 163(j)(3) is unclear. To provide clarity,
and to make these rules consistent, the Treasury Department and the IRS
would define the term syndicate for purposes of section 1256 using the
actual allocation rule from the definition in Sec. 1.448-1T(b)(3).
This proposed definition is also consistent with the definition of a
syndicate used in a number of private letter rulings that were issued
under section 1256. See proposed Sec. 1.1256(e)-2(a).
One commenter asked for clarification on how to compute the amount
of losses to be allocated for purposes of determining syndicate status
under section 1256(e)(3)(A). The commenter provided a particular fact
pattern in which a small business would be caught in an iterative loop
of (a) having net losses due to an interest deduction, (b) which would
trigger disallowance of the exemption in section 163(j)(3), (c) which
would trigger the application of section 163(j)(1) to reduce the amount
of the interest deduction, (d) which would then lead to the taxpayer
having no net losses and therefore being eligible for the application
of section 163(j)(3). To address this fact pattern, the Treasury
Department and the IRS have added rules providing that, for purposes of
section 1256(e)(3)(B), losses are determined without regard to section
163(j). See proposed Sec. Sec. 1.163(j)-2(d)(3) and 1.1256(e)-2(b).
Several commenters requested that the exemption in section
163(j)(3) be broadened to apply to all small businesses without regard
to the parenthetical that denies the section 163(j)(3) exemption for a
small business that is ``a tax shelter that is not permitted to use a
cash method of accounting.'' See section 163(j)(3). One commenter
specifically requested that, for a small business meeting the gross
receipts test in section 448(c), all interests held by limited partners
or limited entrepreneurs be treated as held by owners actively managing
the business even if those interests would not qualify for the active
management exception under section 1256(e)(3)(C). After considering the
comments, the Treasury Department and the IRS have determined that the
requests are contrary to both the statutory language in section
163(j)(3) and the accompanying legislative history and therefore
decline to adopt the comments.
B. Election To Use 2019 ATI To Determine 2020 Section 163(j) Limitation
As stated in the Background section of this preamble, section
163(j)(10)(B)(i) allows a taxpayer to elect to use its 2019 ATI in
determining the taxpayer's section 163(j) limitation for its taxable
year beginning in 2020. Section 1.163(j)-2(b)(3) and (4) of the Final
Regulations provide general rules regarding this election.
These proposed regulations clarify that, if the acquiring
corporation in a transaction to which section 381 applies makes an
election under section 163(j)(10)(B)(i), the acquiring corporation's
2019 ATI for purposes of section 163(j)(10)(B)(i) is its ATI for its
last taxable year beginning in 2019 (subject to the limitation for
short taxable years in section 163(j)(10)(B)(ii)). For example, assume
that T's 2019 ATI is $100 and A's 2019 ATI is $200. If T merges into A
during A's 2020 taxable year in a transaction described in section
368(a)(1)(A), and if A makes an election under section
163(j)(10)(B)(i), A's 2019 ATI for purposes of this election is $200.
Similarly, these proposed regulations clarify that a consolidated
group's 2019 ATI for purposes of section 163(j)(10)(B)(i) is the
consolidated group's ATI for its last taxable year beginning in 2019
(subject to the limitation in section 163(j)(10)(B)(ii)). The Treasury
Department and the IRS request comments on these proposed rules. The
Treasury Department and the IRS also request comments on (1) whether
the 2019 ATI of an acquired corporation in a transaction to which
section 381 applies should be included in the acquiring corporation's
2019 ATI for purposes of section 163(j)(10)(B)(i) and (2) how such a
rule would address more complex fact patterns, such as situations where
the acquiring corporation is acquired in a subsequent transaction
described in section 381, or where the acquired corporation and the
acquiring corporation have different tax years.
IX. Proposed Sec. 1.163(j)-10: Application of Corporate Look-Through
Rules to Tiered Structures
For purposes of determining the extent to which a shareholder's
basis in the stock of a domestic non-consolidated C corporation or CFC
is allocable to an excepted or non-excepted trade or business, Sec.
1.163(j)-10(c)(5)(ii)(B) provides several look-through rules whereby
the shareholder ``looks through'' to the corporation's basis in its
assets.
A commenter pointed out that the application of these look-through
rules may produce distortive results in certain situations. For
example, assume Corporation X's basis in its assets is split equally
between X's excepted and non-excepted trades or businesses, and that
(as a result) X has a 50 percent exempt percentage applied to its
interest expense. However, rather than operate its excepted trade or
business directly, X operates its excepted trade or business through a
wholly owned, non-consolidated subsidiary (Corporation Y), and each of
X and Y borrows funds from external lenders. Assuming for purposes of
this example that neither the anti-avoidance rule in Sec. 1.163(j)-
2(h) nor the anti-abuse rule in Sec. 1.163(j)-10(c)(8) applies, Y's
interest expense would not be subject to the section 163(j) limitation
because Y is engaged solely in an excepted trade or business. Moreover,
a portion of X's interest expense also would be allocable to an
excepted trade or business by virtue of the application of the look-
through rule in proposed Sec. 1.163(j)-10(c)(5)(ii)(B)(2) to X's basis
in Y's stock.
The anti-avoidance rule in proposed Sec. 1.163(j)-2(h) and the
anti-abuse rule in proposed Sec. 1.163(j)-10(c)(8) would preclude the
foregoing result in certain circumstances. However, these proposed
regulations would modify the look-through rule for domestic non-
consolidated C corporations and CFCs to limit the potentially
distortive effect of this look-through rule on tiered structures in
situations to which the anti-avoidance and anti-abuse rules do not
apply. More specifically, these proposed regulations would modify the
look-through rule for non-consolidated C corporations to provide that,
for purposes of determining a taxpayer's basis in its assets used in
excepted and non-excepted trades or businesses, any such corporation
whose stock is being looked through may not itself apply the look-
through rule.
For example, P wholly and directly owns S1, which wholly and
directly owns S2. Each of these entities is a non-consolidated C
corporation to which the small business exemption does not apply. In
determining the extent to which its interest expense is subject to the
section 163(j) limitation, S1 may look through the stock of S2 for
purposes of allocating S1's basis in its S2 stock between excepted and
non-excepted trades or businesses. However, in determining the extent
to which P's interest expense is subject to the section 163(j)
limitation, S1 may not look
[[Page 56874]]
through the stock of S2 for purposes of allocating P's basis in its S1
stock between excepted and non-excepted trades or businesses.
However, the Treasury Department and the IRS are aware that
taxpayers are organized into multi-tiered structures for legitimate,
non-tax reasons. The Treasury Department and the IRS request comments
on the proposed limitation on the application of the corporate look-
through rules. The Treasury Department and the IRS also request
comments on whether there are other situations in which the look-
through rules for domestic non-consolidated C corporations or CFCs
should apply and whether there are other approaches for addressing the
distortions that these proposed rules are intended to minimize.
Proposed Applicability Dates
These Proposed Regulations are proposed to apply to taxable years
beginning on or after 60 days after the date the Treasury Decision
adopting these rules as final regulations is published in the Federal
Register.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may rely on Sec. 1.163-14, Sec. 1.163-15, Sec.
1.163(j)-2(d)(3), or Sec. 1.1256(e)-2 of these Proposed Regulations
for a taxable year beginning after December 31, 2017, and before 60
days after the date the Treasury Decision adopting these rules as final
regulations is published in the Federal Register, provided taxpayers
and their related parties consistently follow all of the rules of the
relevant section of the Proposed Regulations for that taxable year and
for each subsequent taxable year. Taxpayers and their related parties,
within the meaning of sections 267(b) and 707(b)(1), may choose to
apply Sec. 1.163-14, 1.163-15, 1.163(j)-2(d)(3), or 1.1256(e)-2 of the
final version of these Proposed Regulations for a taxable year
beginning after December 31, 2017, and before 60 days after the date
the Treasury Decision adopting these rules as final regulations is
published in the Federal Register, provided that taxpayers and their
related parties consistently apply all of the rules of the relevant
section, as applicable, to that taxable year and each subsequent
taxable year. See also Sec. Sec. 1.163-14(i), 1.163-15(b), 1.163(j)-
2(k)(2), and 1.1256(e)-2(d) of these Proposed Regulations.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), who apply the Final Regulations (as defined in
the Explanation of Provisions) published elsewhere in this issue of the
Federal Register to a taxable year beginning after December 31, 2017,
and before 60 days after the Treasury Decision adopting these rules as
final regulations is published in the Federal Register may rely on
Sec. Sec. 1.163(j)-1(b)(1)(iv)(B) and 1.163(j)-1(b)(1)(iv)(E) of these
Proposed Regulations for a taxable year beginning after December 31,
2017, and before 60 days after the Treasury Decision adopting these
rules as final regulations is published in the Federal Register,
provided that taxpayers and their related parties consistently apply
the rules of both Sec. Sec. 1.163(j)-1(b)(1)(iv)(B) and 1.163(j)-
1(b)(1)(iv)(E) of these Proposed Regulations, and, if applicable,
Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2,
1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-
1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-
36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they
effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and
1.383-1), and 1.1504-4, to that taxable year and each subsequent
taxable year See also Sec. 1.163(j)-1(c)(4)(i) of these Proposed
Regulations.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), who apply the Final Regulations published
elsewhere in this issue of the Federal Register to a taxable year
beginning after December 31, 2017, and before 60 days after the
Treasury Decision adopting these rules as final regulations is
published in the Federal Register, may rely on the rules in Sec.
1.163(j)-2(b)(3)(iii) and (iv) of these Proposed Regulations for such
taxable year, provided that taxpayers and their related parties
consistently follow the rules of both Sec. 1.163(j)-2(b)(3)(iii) and
(iv) for that taxable year and for each subsequent taxable year
beginning before 60 days after the Treasury Decision adopting these
rules as final regulations is published in the Federal Register.
Taxpayers not applying the Final Regulations to taxable years beginning
before November 13, 2020 may not rely on the rules in Sec. 1.163(j)-
2(b)(3)(iii) and (iv) of these Proposed Regulations for those taxable
years. See also Sec. 1.163(j)-2(k)(2) of these Proposed Regulations.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b), who apply the Final Regulations published elsewhere
in this issue of the Federal Register to a taxable year beginning after
December 31, 2017, and before 60 days after the Treasury Decision
adopting these rules as final regulations is published in the Federal
Register may rely on the rules in Sec. 1.163(j)-10(c)(5)(ii)(D)(2),
1.469-4(d)(6), or 1.469-9(b)(2) of these Proposed Regulations for a
taxable year beginning after December 31, 2017, and before 60 days
after the Treasury Decision adopting these rules as final regulations
is published in the Federal Register, provided that taxpayers and their
related parties consistently follow the rules of Sec. 1.163(j)-
10(c)(5)(ii)(D)(2), 1.469-4(d)(6), or 1.469-9(b)(2) of these Proposed
Regulations, as applicable, and, if applicable, Sec. Sec. 1.263A-9,
1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7,
1.383-0, 1.383-1, 1.469-4, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-
3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79,
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, for
that taxable year and for each subsequent taxable year. See also
Sec. Sec. 1.163(j)-10(f)(2) and 1.469-11(a)(1) and (4) of these
Proposed Regulations.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b), may rely on the rules in Sec. 1.163(j)-6 of these
Proposed Regulations for a taxable year beginning after December 31,
2017, and before 60 days after the Treasury Decision adopting these
rules as final regulations is published in the Federal Register,
provided that taxpayers and their related parties also apply the rules
of Sec. 1.163(j)-6 in the Final Regulations and consistently follow
all of those rules for that taxable year and for each subsequent
taxable year. See also Sec. 1.163(j)-6(p)(2) of these Proposed
Regulations.
Taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), who apply the Final Regulations published
elsewhere in this issue of the Federal Register to a taxable year
beginning after December 31, 2017, and before 60 days after the date
the Final Regulations are published in the Federal Register, may rely
on Sec. Sec. 1.163(j)-7 and 1.163(j)-8 of these Proposed Regulations
for that taxable year, provided the taxpayers and their related parties
also rely on Sec. Sec. 1.163(j)-7 and 1.163(j)-8 of these Proposed
Regulations and apply the Final Regulations for each subsequent taxable
year. Taxpayers who choose not to apply the Final Regulations to a
taxable year beginning after December 31, 2017, and before 60 days
after the date the Final Regulations are published in the Federal
Register may not rely on either Sec. 1.163(j)-7 or 1.163(j)-8 of these
Proposed Regulations for that taxable year. For any taxable year
beginning on or after 60 days after the date the Final Regulations are
published in the
[[Page 56875]]
Federal Register and before 60 days after the date the Treasury
Decision adopting these Proposed Regulations as final regulations is
published in the Federal Register, taxpayers and their related parties,
within the meaning of sections 267(b) and 707(b)(1), may rely on
Sec. Sec. 1.163(j)-7 and 1.163(j)-8 of these Proposed Regulations
provided they consistently follow all of the rules of Sec. Sec.
1.163(j)-7 and 1.163(j)-8 for such taxable year and for each subsequent
taxable year beginning before 60 days after the Treasury Decision
adopting these Proposed Regulations as final regulations is published
in the Federal Register. See also Sec. Sec. 1.163(j)-7(m) and
1.163(j)-8(j) of these Proposed Regulations. Taxpayers and their
related parties who rely on Sec. 1.163(j)-7 of these Proposed
Regulations for any taxable year ending before November 13, 2020 can
make a CFC group election or a safe-harbor election even if the
deadline provided in Sec. 1.163(j)-7(e)(5)(iii) or (h)(5)(i) of these
Proposed Regulations has passed. Such taxpayers and their related
parties are permitted to make the election on an amended Federal income
tax return filed on or before the due date (taking into account
extensions, if any) of the original Federal income tax return for the
first taxable year ending after November 13, 2020.
See part III.B of the Explanation of Provisions for rules
concerning reliance on these Proposed Regulations with respect to
section 163(j) interest dividends.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 13771, 13563, and 12866 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits, including potential economic, environmental, public
health and safety effects, distributive impacts, and equity. Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, reducing costs, harmonizing rules, and promoting flexibility.
The Executive Order 13771 designation for any final rule resulting from
these proposed regulations will be informed by comments received. The
preliminary Executive Order 13771 designation for this proposed rule is
regulatory.
These proposed regulations have been designated by the Office of
Information and Regulatory Affairs as subject to review under Executive
Order 12866 pursuant to the Memorandum of Agreement (MOA, April 11,
2018) between the Treasury Department and the Office of Management and
Budget (OMB) regarding review of tax regulations. OMB has designated
the proposed regulations as economically significant under section 1(c)
of the MOA. Accordingly, the proposed regulations have been reviewed by
OMB's Office of Information and Regulatory Affairs.
A. Background and Need for These Proposed Regulations
Section 163(j), substantially revised by the Tax Cuts and Jobs Act
(TCJA), provides a set of relatively complex statutory rules that
impose a limitation on the amount of business interest expense that a
taxpayer may deduct for Federal tax purposes. This limitation does not
apply to businesses with gross receipts of $25 million or less
(inflation adjusted). This provision has the general effect of putting
debt-financed investment by businesses on a more equal footing with
equity-financed investment, a treatment that Congress believed will
lead to a more efficient capital structure for firms. See Senate Budget
Explanation of the Bill as Passed by SFC (2017-11-20) at pp. 163-4.
As described in the Background section earlier, the Coronavirus
Aid, Relief, and Economic Security Act (CARES Act) amended section
163(j) to provide special rules relating to the adjusted taxable income
(ATI) limitation for taxable years beginning in 2019 or 2020.
Because this limitation on deduction for business interest expense
is new, taxpayers would benefit from regulations that explain key terms
and calculations. The Treasury Department and the IRS published
proposed regulations in December 2018 (2018 Proposed Regulations) and
are issuing final regulations simultaneously with the current proposed
regulations. This current set of proposed regulations covers topics
that were reserved in the 2018 Proposed Regulations, were raised by
commenters to the proposed regulations, or need to be re-proposed.
B. Overview of the Proposed Regulations
The proposed regulations provide guidance on the definition of
interest as it relates to income flowing through regulated investment
companies (RICs); debt-financed distributions from pass-through
entities; the treatment of business interest expense for publicly
traded partnerships and trading partnerships \10\; the application of
the section 163(j) limitation in the context of self-charged interest;
and the treatment of excess business interest expense in tiered-
partnership structures. The proposed regulations also modify the
definition of real property development and real property redevelopment
in section 1.469-9 of the regulations and the definition of syndicate
for purposes of applying the small business exception in section
163(j)(3). The proposed regulations also re-propose rules regarding the
application of the interest limitation to foreign corporations
(including controlled foreign corporations as defined in section
957(a)) and United States shareholders of controlled foreign
corporations, and the applicability of the section 163(j) limitation to
foreign persons with U.S. effectively connected income.
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\10\ A trading partnership is a partnership engaged in the per
se non-passive activity of trading personal property (including
market securities) for the account of owners of interests in the
activity, as described in section 1.469-1T(e)(6) (trading
partnerships).
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C. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of these proposed regulations relative to a no-action baseline
that reflects anticipated Federal income tax-related behavior in the
absence of these regulations.
2. Summary of Economic Effects
The proposed regulations provide certainty and clarity to taxpayers
regarding terms and calculations that are contained in section 163(j),
which was substantially modified by TCJA. In the absence of this
clarity, the likelihood that different taxpayers would interpret the
rules regarding the deductibility of business interest expense
differently would be exacerbated. In general, overall economic
performance is enhanced when businesses face more uniform signals about
tax treatment. Certainty and clarity over tax treatment also reduce
compliance costs for taxpayers.
For those situations where taxpayers would generally adopt similar
interpretations of the statute even in the absence of guidance, the
proposed regulations provide value by helping to ensure that those
interpretations are consistent with the intent and purpose of the
statute. For example, the proposed regulations may specify a tax
treatment that few or no taxpayers would adopt in the absence of
specific guidance.
The Treasury Department and the IRS project that the proposed
regulations
[[Page 56876]]
will have an annual economic effect greater than $100 million ($2019).
This determination is based on the substantial volume of business
interest payments in the economy \11\ and the general responsiveness of
business investment to effective tax rates,\12\ one component of which
is the deductibility of interest expense. Based on these two
magnitudes, even modest changes in the deductibility of interest
payments (and in the certainty of that deductibility) provided by the
proposed regulations, relative to the no-action baseline, can be
expected to have annual effects greater than $100 million. This claim
is particularly likely to hold for the first set of general section
163(j) guidance that is promulgated following major legislation, such
as TCJA, and for other major guidance, which we have determined
includes these proposed regulations.
---------------------------------------------------------------------------
\11\ Interest deductions in tax year 2013 for corporations,
partnerships, and sole proprietorships were approximately $800
billion.
\12\ See E. Zwick and J. Mahon, ``Tax Policy and Heterogeneous
Investment Behavior,'' at American Economic Review 2017, 107(1):
217-48 and articles cited therein.
---------------------------------------------------------------------------
Regarding the nature of the economic effects, the Treasury
Department and the IRS project that the proposed regulations will
increase investment in the United States and increase the proportion
that is debt-financed, relative to the no-action baseline. We have
further determined that these effects are consistent with the intent
and purpose of the statute. Because taxpayer favorable provisions will
lead to a decrease in Federal tax revenue relative to the no-action
baseline, there may be an increase in the Federal deficit relative to
the no-action baseline. This may lead to a decrease in investment by
taxpayers not directly affected by these proposed regulations, relative
to the no-action baseline. This effect should be weighed against the
enhanced efficiency arising from the clarity and enhanced consistency
with the intent and purpose of the statute provided by these
regulations. The Treasury Department and the IRS have determined that
the proposed regulations provide a net benefit to the U.S. economy.
The Treasury Department and the IRS have not undertaken more
precise quantitative estimates of these effects because many of the
definitions and calculations under 163(j) are new and many of the
economic decisions that are implicated by these proposed regulations
involve highly specific taxpayer circumstances. We do not have readily
available data or models to estimate with reasonable precision the
types and volume of different financing arrangements that taxpayers
might undertake under the proposed regulations versus the no-action
baseline.
In the absence of such quantitative estimates, the Treasury
Department and the IRS have undertaken a qualitative analysis of the
economic effects of the proposed regulations relative to the no-action
baseline and relative to alternative regulatory approaches. This
analysis is presented in Part I.C.3 of this Special Analyses.
The Treasury Department and the IRS solicit comments on these
findings and more generally on the economic effects of these proposed
regulations. The Treasury Department and the IRS particularly solicit
data, other evidence, or models that could be used to enhance the rigor
of the process by which the final regulations might be developed.
3. Economic Effects of Specific Provisions
a. Definition of Interest
The final regulations set forth several categories of amounts and
transactions that generate interest for purposes of section 163(j). The
proposed regulations provide further guidance on the definition of
interest relevant to the calculation of interest expense and interest
income. In particular, the proposed regulations provide rules under
which the dividends paid by a RIC that earns net business interest
income (referred to as section 163(j) interest dividends) are to be
treated as interest income by the RIC's shareholders. That is, under
the proposed regulations, certain interest income earned by the RIC and
paid to a shareholder as a dividend is treated as if the shareholder
earned the interest income directly for purposes of section 163(j).
To the extent that taxpayers believed, in the absence of the
proposed regulations, that dividends paid by RICs are not treated as
business interest income for the purposes of the section 163(j)
limitation, then taxpayers will likely respond to the proposed
regulations by reducing their holding of other debt instruments and
increasing investment in RICs. The Treasury Department and the IRS have
determined that this treatment is consistent with the intent and
purpose of the statute.
Number of Affected Taxpayers. The Treasury Department and the IRS
have determined that the rules regarding section 163(j) interest
dividends will potentially affect approximately 10,000 RICs. The
Treasury Department and the IRS do not have readily available data on
the number of RIC shareholders that would receive section 163(j)
interest dividends that the shareholder could treat as business
interest income for purposes of the shareholder's section 163(j)
limitation.
b. Provisions Related to Partnerships
i. Trading Partnerships
Section 163(j) limits the deductibility of interest expense at the
partnership level. These proposed regulations address commenter
concerns about the interaction between this section 163(j) limitation
and the section 163(d) partner level limitation on interest expense
that existed prior to TJCA. Under logic described in the preamble to
the 2018 Proposed Regulations, section 163(j) limitations would apply
at the partnership level while section 163(d) limitations would apply
at the partner level and these tests would be applied independently.
Commenters suggested and Treasury has agreed that the correct
interpretation of the statute is to exempt interest expense that is
limited at the partner level by section 163(d) from the partnership
level section 163(j) limitation in accordance with the language of
section 163(j)(5).
These proposed regulations provide that interest expense at the
partnership level that is allocated to non-materially participating
partners subject to section 163(d) is not included in the section
163(j) limitation calculation of the partnership. Generally, the
section 163(d) limitation is more generous than the section 163(j)
limitation. Relative to the 2018 Proposed Regulations, this change may
encourage these partners to incur additional interest expense because
they will be less likely to be limited in their ability to use it to
offset other income. Commenters argued that exempting from section
163(j) any interest expense allocated to non-materially participating
partners subject to section 163(d) will treat this interest expense in
the same way as the interest expense generated through separately
managed accounts, which are not subject to section 163(j) limitations.
The Treasury Department and the IRS project that these proposed
regulations will result in additional investment in trading
partnerships and generally higher levels of debt in any given trading
partnership relative to the 2018 Proposed Regulations. Because
investments in trading partnerships may be viewed as economically
similar to investments in separately managed accounts arrangements, we
further project that the proposed regulations, by making the tax
treatments of these two arrangements generally similar, will
[[Page 56877]]
improve U.S. economic performance relative to the no-action baseline.
Number of Affected Taxpayers. The Treasury Department and the IRS
have determined that the rules regarding trading partnerships will
potentially affect approximately 275,000 taxpayers. This number was
reached by determining, using data for the 2017 taxable year, the
number of Form 1065 and Form 1065-B filers that (1) completed Schedule
B to Form 1065 and marked box b, c, or d in question 1 to denote
limited partnership, limited liability company, or limited liability
partnership status; and (2) have a North American Industry
Classification System (NAICS) code starting with 5231 (securities and
commodity contracts intermediation and brokerage), 5232 (securities and
commodity exchanges), 5239 (other financial investment activities), or
5259 (other investment pools and funds).
Additionally, the Treasury Department and the IRS have determined
that the rules regarding publicly traded partnerships will potentially
affect approximately 80 taxpayers. This number was reached by
determining, using data for the 2017 taxable year, the number of Form
1065 and 1065-B filers with gross receipts exceeding $25 million that
answered ``yes'' to question 5 on Schedule B to Form 1065 denoting that
the entity is a publicly traded partnership. The Treasury Department
and the IRS do not have readily available data on the number of filers
that are tax shelters that are potentially affected by these
provisions.
ii. Debt-Financed Distributions
Prior to TCJA, partners were responsible for determining the
applicability of any limitations on the use of proceeds from debt
because limitations on interest expense deductibility were determined
at the partner level. Under section 163(j) as amended by TCJA, the
partnership is required to complete a calculation to determine its
limitation on trade or business interest expense. These proposed
regulations provide guidance on the method that partnerships and
partners should use to allocate interest expense in cases where a
partner receives a distribution financed from debt. The Treasury
Department and the IRS project that this guidance will reduce taxpayer
uncertainty regarding the application of section 163(j) in this
situation relative to the no-action baseline.
The proposed regulations require that partnerships allocate the
interest expense of the partners not receiving a debt-financed
distribution first. This interest expense is allocated to trade or
business expense to the extent of the partnership's expenses. The
character of any remaining interest expense is determined based on the
partnership's asset basis. Next, the proposed regulations allocate the
interest expense of the partner receiving the debt-financed
distribution. If there is any remaining business expense that was not
used by the other partners it is used first to allocate the interest
expense. Then the partner receiving the debt financed distribution
looks to the use of the proceeds of the distribution to determine the
character of any additional interest expense.
This procedure provides lower compliance costs relative to
alternative regulatory approaches. Any alternative method that required
information on the partner's use of the proceeds to determine the
partnership level section 163(j) limitation would have increased
compliance costs for partnerships and partners because it would require
a new reporting from partners to partnerships. In cases of tiered
partnerships, this reporting could become extremely complex. The method
outlined in these proposed regulations avoids the need for partnerships
and other partners to have information about the use the debt-financed
distribution proceeds. However, it maintains that interest expense
allocated to the partner receiving the debt-financed distribution could
still be subject to other limitations besides section 163(j) based on
the use of the proceeds. For example, proceeds used for personal
expenditures would still be subject to section 163(h) limitations on
interest expense, which may be seen as an important existing anti-abuse
provision.
The proposed procedure bases the allocation rules on optional and
general allocation rules outlined in a previously issued notice, Notice
89-35, which will minimize compliance costs to partnerships (relative
to the no-action baseline) to the extent that they are already familiar
with allocating interest expense first to the partnership's business
expenses and subsequently based on assets. Relative to the no-action
baseline, the Treasury Department and the IRS expect these proposed
regulations will reduce taxpayer uncertainty regarding the application
of section 163(j). Treasury and IRS expect that this resolution of
uncertainty itself will reduce taxpayer compliance costs and encourage
similarly situated taxpayers to interpret section 163(j) similarly.
Number of Affected Taxpayers. The Treasury Department and the IRS
are not currently able to determine the number of taxpayers affected by
rules regarding debt financed distributions because debt financed
distributions are not separately identified on tax forms, and therefore
using the numbers of entities reporting interest on a Form K-1,
Schedule C or Schedule E would produce overly broad results.
iii. Tiered Partnerships
Section 163(j) does not explicitly address how the interest
deduction limitation should be applied to tiered partnerships. The 2018
Proposed Regulations requested comments on the treatment of tiered
partnership structures. Suppose that an upper-tier partnership (UTP) is
a partner of a lower-tier partnership (LTP), and that the LTP has
business interest expense that is limited under section 163(j). Under
the 2018 Proposed Regulations, the UTP would receive an excess business
interest expense (EBIE) carryforward from the LTP. In response to
comments received, these proposed regulations adopt the Entity Approach
and specify that this EBIE carryforward should not be allocated to the
partners of the UTP for purposes of section 163(j).
While some commenters favored the Entity Approach that these
proposed regulations adopt, others favored an alternative under which
the EBIE carryforward would be allocated to the UTP's partners
(Aggregate Approach). Additionally, if the UTP's partner were itself a
partnership, the EBIE would again be allocated to that partnership's
partners. This would continue until the EBIE is eventually allocated to
a non-partnership partner. Relative to the Entity Approach, the
Aggregate Approach generally places greater compliance burden on
partners. Under the Aggregate Approach, partners would be required to
keep records linking separate amounts of EBIE to the partnerships that
generated them. In simple partnership structures, this is not onerous;
however, in a partnership structure with many tiers and many partners,
this would prove cumbersome. In contrast, under the Entity Approach,
only the UTP keeps a record of the EBIE carryforward.
In summary, the Treasury Department and the IRS project lower
record-keeping requirements, higher compliance rates, and easier
compliance monitoring of tiered partnerships under the Entity Approach
relative to the Aggregate Approach, with no meaningful difference in
the economic decisions that taxpayers would make under the two
approaches.
[[Page 56878]]
Moreover, relative to the no-action baseline, the Treasury
Department and the IRS expect these proposed regulations for tiered
partnerships will reduce taxpayer uncertainty regarding the application
of section 163(j). Treasury and IRS expect that this resolution of
uncertainty itself will reduce taxpayer compliance costs and encourage
similarly situated taxpayers to interpret section 163(j) similarly.
iv. Self-Charged Lending
The 2018 Proposed Regulations requested comments on the treatment
of lending transactions between a partnership and a partner (self-
charged lending transactions). Suppose that a partnership receives a
loan from a partner and allocates the resulting interest expense to
that partner. Prior to the TCJA, the interest income and interest
expense from this loan would net precisely to zero on the lending
partner's tax return. Under section 163(j) as revised by TCJA, however,
the partnership's interest expense deduction may now be limited.
Therefore, in absence of specific regulatory guidance, the lending
partner may receive interest income from the partnership accompanied by
less-than-fully-offsetting interest expense. Instead, the lending
partner would receive EBIE, which would not be available to offset his
personal interest income. This outcome has the effect of increasing the
cost of lending transactions between partners and their partnerships
relative to otherwise similar financing arrangements.
To avoid this outcome, these proposed regulations treat the lending
partner's interest income from the loan as excess business interest
income (EBII) from the partnership, but only to the extent of the
partner's share of any EBIE from the partnership for the taxable year.
This allows the interest income from the loan to be offset by the EBIE.
The business interest expense (BIE) of the partnership attributable to
the lending transaction will thus be treated as BIE of the partnership
for purposes of applying section 163(j) to the partnership.
The Treasury Department and the IRS expect that these proposed
regulations will lead a higher proportion of self-charged lending
transactions in partnership financing, relative to the no-action
baseline. We further project that these proposed regulations will
increase the proportion of partnership financing that is debt-financed
relative to the no-action baseline. We have determined that these
effects are consistent with the intent and purpose of the statute.
Number of Affected Taxpayers. The Treasury Department and the IRS
do not have readily available data to determine the number of taxpayers
affected by rules regarding self-charged interest because no reporting
modules currently connect these payments by and from partnerships.
c. Provisions Related to Controlled Foreign Corporations (CFCs)
i. How To Apply Section 163(j) When CFCs Have Shared Ownership
The Final Regulations clarify that section 163(j) and the section
163(j) regulations apply to determine the deductibility of a CFC's
business interest expense for tax purposes in the same manner as these
provisions apply to a domestic corporation. These proposed regulations
provide further rules and guidance on how section 163(j) applies to
CFCs when CFCs have shared ownership and are eligible to be members of
CFC groups.
The Treasury Department and the IRS considered three options with
respect to the application of section 163(j) to CFC groups. The first
option was to apply the 163(j) limitation to CFCs on an individual
basis, regardless of whether CFCs have shared ownership. However, if
section 163(j) is applied on an individual basis, business interest
deductions of individual CFCs may be limited by section 163(j) even
when, if calculated on a group basis, business interest deductions
would not be limited. Taxpayers could restructure or ``self-help'' to
mitigate the effects of the section 163(j) limitation, but that option
involves economically restructuring costs for the taxpayer (relative to
the third option, described subsequently) with no corresponding
economically productive activity.
The second option, which was proposed in the 2018 Proposed
Regulations, was to allow an election to treat related CFCs and their
U.S. shareholders as a group. Under this option, while the section
163(j) rules would still be computed at the individual CFC level, the
``excess taxable income'' of a CFC could be passed up from lower-tier
CFCs to upper-tier CFCs and U.S. shareholders in the same group. Excess
taxable income is the amount of income by which a CFC's adjusted
taxable income (ATI) exceeds the threshold amount of ATI below which
there would be disallowed business expense.
Many comments suggested that computing a section 163(j) limitation
for each CFC and rolling up CFC excess taxable income would be
burdensome for taxpayers, especially since some multinational
organizations have hundreds of CFCs. In addition, comments noted that
the ability to pass up excess taxable income would encourage
multinational organizations to restructure such that CFCs with low
interest payments and high ATI are lower down the ownership chain and
CFCs with high interest payments and low ATI are higher up in the chain
of ownership. Similar to the first option, this restructuring would be
expensive to taxpayers without any corresponding productive economic
activity.
The third option was to allow taxpayers to elect to apply the
section 163(j) rules to CFC groups on an aggregate basis, similar to
the rules applicable to U.S. consolidated groups. This option was
suggested by many comments and is the approach taken in the proposed
regulations. Under this option, a single 163(j) limitation is computed
for a CFC group by summing the items necessary for this computation
(e.g., current-year business interest expense and ATI) across all CFC
group members. The CFC group's limitation is then allocated to each CFC
member using allocation rules similar to those that apply to U.S.
consolidated groups.
This option reduces the compliance burden on taxpayers in
comparison to applying the section 163(j) rules on an individual CFC
basis and calculating the excess taxable income to be passed up from
lower tier CFCs to higher tier CFCs. In comparison to the first and
second options, this option also removes the incentive for taxpayers to
undertake costly restructuring, since the location of interest payments
and ATI among CFC group members will not affect the interest
disallowance for the group.
The proposed regulations also set out a number of rules to govern
membership in a CFC group. These rules specify which CFCs can be
members of the same CFC group, how CFCs with U.S. effectively connected
income (ECI) should be treated, and the timing for making or revoking a
CFC group election. These rules provide clarity and certainty to
taxpayers regarding the CFC group election for section 163(j). In the
absence of these regulations, taxpayers would face uncertainty
regarding CFC group membership, and may make financing decisions or
undertake restructuring that would be inefficient relative to the
proposed regulations.
Number of Affected Taxpayers. The population affected by this
proposed rule includes any taxpayer with ownership in a CFC group,
consisting of two or more CFCs that has average gross receipts over a
three year period in excess of $25 million. The Treasury
[[Page 56879]]
Department and the IRS estimate that there are approximately 7,500
taxpayers with two or more CFCs based on counts of e-filed tax returns
for tax years 2015-2017. This estimate includes C corporations, S
corporations, partnerships, and individuals with CFC ownership.
ii. CFC Excess Taxable Income and ATI of U.S. Shareholders
Generally, for the purposes of computing interest expense
disallowed under section 163(j), deemed income inclusions, such as
subpart F and GILTI inclusions, are excluded from a U.S. shareholder's
ATI under the Final Regulations. The proposed regulations allow a U.S.
shareholder to add back to its ATI a percentage of its deemed income
inclusions attributable to an applicable CFC. That percentage is equal
to the ratio of the CFC's excess taxable income to its ATI.
The Treasury Department and the IRS considered three options with
respect to the addition of deemed income inclusions to a U.S.
shareholder's ATI. The first option is to allow such inclusions to be
added to ATI with respect to any of a taxpayer's applicable CFCs
regardless of whether a CFC group election is made. However, under this
option, taxpayers with a number of highly leveraged CFCs would have the
incentive to not make a CFC group election and concentrate debt in
certain CFCs. The taxpayer could thereby reduce the leverage of other
CFCs in order to create excess taxable income in those CFCs. This
excess taxable income could be then passed up to increase the U.S.
shareholder's ATI. This incentive could lead to costly debt shifting
among CFCs with no corresponding productive economic activity.
The second option considered was to allow such income inclusions to
be added to ATI with respect to CFC group members only. Deemed income
attributable to CFCs that are not members of groups would not be
allowed to be added to a U.S. shareholder's ATI. This would remove the
incentive for taxpayers to aggregate debt in certain CFCs, since if
CFCs are treated as members of a group, then the distribution of
interest payments across members will not affect the total excess
taxable income of the group. However, comments noted that this option
would not allow deemed income from stand-alone CFCs, which do not meet
the requirements to join a CFC group, to increase shareholders' ATI.
The third option, which is proposed by the Treasury Department and
the IRS, is to allow such income inclusions to be added to ATI with
respect to both CFC group members and stand-alone CFCs. Under this
option, if CFCs are eligible to be members of a CFC group, then the
group election must be made in order for deemed inclusions attributable
to these CFCs to increase shareholder ATI. The ATI of a U.S.
shareholder can also be increased with respect to CFCs that are not
eligible to be members of CFC groups. In this way, the rule does not
penalize, relative to shareholders of CFC groups, shareholders which
own only one CFC or own CFCs which for other reasons are not eligible
for group membership.
Number of Affected Taxpayers. The population of affected taxpayers
includes any taxpayer with a CFC since the proposed rule affects both
stand-alone CFCs as well as CFC groups. The Treasury Department and the
IRS estimate that there are approximately 10,000 to 11,000 affected
taxpayers based on a count of e-filed tax returns for tax years 2015-
2017. These counts include C corporations, S corporations,
partnerships, and individuals with CFC ownership that meet a $25
million three-year average gross receipts threshold. The Treasury
Department and the IRS do not have readily available data on the number
of filers that are tax shelters that are potentially affected by these
provisions.
d. Election To Use 2019 ATI To Determine 2020 Section 163(j) Limitation
for Consolidated Groups
The proposed regulations provide that if a taxpayer filing as a
consolidated group elects to substitute its 2019 ATI for its 2020 ATI,
that group can use the consolidated group ATI for the 2019 taxable
year, even if membership of the consolidated group changed in the 2020
taxable year. For example, suppose consolidated group C has three
members in the 2019 taxable year, P, the common parent of the
consolidated group, and S1 and S2, which are both wholly owned by P. In
the 2019 taxable year, each member of consolidated group C had $100 of
ATI on a stand-alone basis, for a total of $300 of ATI for the
consolidated group C. In the 2020 taxable year, consolidated group C
sells all of the stock of S2 and acquires all of the stock of a new
member, S3. In the 2019 taxable year, S3 had $50 in ATI on a stand-
alone basis. Under the proposed regulations, consolidated group C may
elect to use $300 in ATI from 2019 as a substitute for its ATI in the
2020 taxable year.
The Treasury Department and the IRS considered as an alternative
basing the 2019 ATI on the membership of the consolidated group in the
2020 taxable year. In the example in the previous paragraph, this
approach would subtract out the $100 in ATI from S2 and add the $50 in
ATI from S3, for a total of $250 in 2019 ATI that could potentially be
substituted for 2020 ATI for consolidated group C. This approach would
add burden to taxpayers relative to the proposed regulations by
requiring additional calculations and tracking of ATI on a member-by-
member basis to determine the amount of 2019 ATI that can be used in
the 2020 taxable year without providing any general economic benefit.
In addition, the 2019 tax year will have closed for many taxpayers
by the time these proposed regulations will be published. This implies
that proposed rule of basing the consolidated group composition on the
2019 taxable year to calculate the amount of 2019 ATI that can be used
in the 2020 taxable year will, relative to the alternative approach of
using the composition in the 2020 taxable year, reduce the incentive
for taxpayers to engage in costly mergers, acquisitions, or divestures
to achieve a favorable tax result.
Number of Affected Taxpayers. The Treasury Department and the IRS
estimate that approximately 34,000 corporate taxpayers filed a
consolidated group tax return for tax year 2017. This represents an
upper-bound of the number of taxpayers affected by the proposed rule as
not all consolidated groups would need to calculate the amount of
section 163(j) interest limitation in tax years 2019 and 2020.
D. Paperwork Reduction Act
The collection of information in these Proposed Regulations has
been submitted to the Office of Management and Budget for review in
accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)). An agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it displays
a valid OMB control number. The collection of information in these
Proposed Regulations has been submitted to the Office of Management and
Budget for review in accordance with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)).
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
return information are confidential, as required by section 6103.
1. Collections of Information
The collections of information subject to the Paperwork Reduction
Act in these
[[Page 56880]]
Proposed Regulations are in proposed Sec. Sec. 1.163(j)-6(d)(5),
1.163(j)-6(g)(4), and 1.163(j)-7.
The collections of information in proposed Sec. Sec. 1.163(j)-
6(d)(5) and 1.163(j)-6(g)(4) are required to make two elections
relating to changes made to section 163(j) by the CARES Act. The
election under proposed Sec. 1.163(j)-6(d)(5) is for a passthrough
taxpayer to use the taxpayer's ATI for the last taxable year beginning
in 2019 as its ATI for any taxable year beginning in 2020, in
accordance with section 163(j)(10)(B). The election under proposed
Sec. 1.163(j)-6(g)(4) relates to excess business interest expense of a
partnership for any taxable year beginning in 2019 that is allocated to
a partner. Section 163(j)(10)(A)(ii)(II) provides that, unless the
partner elects out, in 2020, the partner treats 50 percent of the
excess business interest expense as not subject to the section 163(j)
limitation. If the partner elects out, the partner treats all excess
business interest expense as subject to the same limitations as other
excess business interest expense allocated to the partner.
Revenue Procedure 2020-22 describes the time and manner for making
these elections. For both elections, taxpayers make the election by
timely filing a Federal income tax return or Form 1065, including
extensions, an amended Federal income tax return, amended Form 1065, or
administrative adjustment request, as applicable. More specifically,
taxpayers complete the Form 8990, ``Limitation on Business Interest
Expense under Section 163(j),'' using the taxpayer's 2019 ATI and/or
not applying the rule in section 163(j)(10)(ii)(II), as applicable. No
formal statements are required to make these elections. Accordingly,
the reporting burden associated with the collections of information in
proposed Sec. 1.163(j)-6(d)(5) and -6(g)(4) will be reflected in the
IRS Form 8990 Paperwork Reduction Act Submissions (OMB control number
1545-0123).
The collections of information in proposed Sec. 1.163(j)-7 are
required for taxpayers to make an election to apply section 163(j) to a
CFC group (CFC group election) or an annual election to exempt a CFC or
CFC group from the section 163(j) limitation (safe-harbor election).
The elections are made by attaching a statement to the US shareholder's
annual return. The CFC group election remains in place until revoked
and may not be revoked for any period beginning prior to 60 months
following the period for which it is made. The safe-harbor election is
made on an annual basis.
Under Sec. 1.964-1(c)(3)(i), no election of a foreign corporation
is effectuated unless the controlling domestic shareholder provides a
statement with their return and notice of the election to the minority
shareholders under Sec. 1.964-1(c)(3)(ii) and (iii). See also, Sec.
1.952-2(b)-(c). These collections are necessary to ensure that the
election is properly effectuated, and that taxpayers properly report
the amount of interest that is potentially subject to the limitation.
2. Future Modifications to Forms To Collect Information
At this time, no modifications to any forms, including the Form
8990, ``Limitation on Business Interest Expense IRC 163(j),'' are
proposed with regard to the elections under section 163(j)(10), or the
CFC group or safe-harbor elections. The Treasury Department and the IRS
are considering revisions to the Instructions for Form 8990 to reflect
changes made to section 163(j)(10) regarding the elections under
proposed Sec. Sec. 1.163(j)-6(d)(5) and 1.163(j)-6(g)(4). For purposes
of the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)), the
reporting burden of Form 8990 is associated with OMB control number
1545-0123. In the 2018 Proposed Regulations, Form 8990 was estimated to
be required by fewer than 92,500 taxpayers.
If an additional information collection requirement is imposed
through these regulations in the future, for purposes of the Paperwork
Reduction Act, any reporting burden associated with these regulations
will be reflected in the aggregated burden estimates and the OMB
control numbers for general income tax forms or the Form 8990,
``Limitation on Business Interest Expense Under Section 163(j)''.
The forms are available on the IRS website at:
------------------------------------------------------------------------
Form OMB No. IRS website link
------------------------------------------------------------------------
Form 1040.................... 1545-0074 https://www.irs.gov/pub/irs-pdf/f1040.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf).
Form 1120.................... 1545-0123 https://www.irs.gov/pub/irs-pdf/f1120.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1120.pdf).
Form 1120S................... https://www.irs.gov/pub/irs-pdf/f1120s.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1120s.pdf).
Form 1065.................... https://www.irs.gov/pub/irs-pdf/f1065.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i1065.pdf).
Form 1120-REIT............... https://www.irs.gov/pub/
irs-prior/f1120rei_
2018.pdf (Instructions:
https://www.irs.gov/pub/irs-pdf/i1120rei.pdf).
Form 8990.................... https://www.irs.gov/pub/irs-access/f8990_accessible.pdf
(Instructions: https://www.irs.gov/pub/irs-pdf/i8990.pdf).
------------------------------------------------------------------------
In addition, when available, drafts of IRS forms are posted for
comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.htm.
IRS forms are available at https://www.irs.gov/forms-instructions.
Forms will not be finalized until after they have been approved by OMB
under the PRA.
3. Burden Estimates
The following estimates for the collections of information in these
proposed regulations are based on the most recently available
Statistics of Income (SOI) tax data.
For the collection of income in proposed Sec. 1.163(j)-6(d)(5),
where a passthrough taxpayer elects to use the taxpayer's ATI for the
last taxable beginning in 2019 as the taxpayer's ATI for any taxable
year beginning in 2020, the most recently available 2017 SOI tax data
indicates that, on the high end, the estimated number of respondents is
49,202. This number was determined by examining, for the 2017 tax year,
Form 1065 and Form 1120-S filers with greater than $26 million in gross
receipts that have reported interest expense, and do not have an NAICS
code that is associated with a trade or business that normally would be
excepted from the section 163(j) limitation.
For the collection of information under Sec. 1.163(j)-6(g)(4), in
which a partner elects out of treating 50 percent of any excess
business interest expense allocated to the partner in 2019 as not
subject to a limitation in 2020, the Treasury Department and the IRS
estimate that only taxpayers that actively want to reduce their
deductions will make this election. The application of the base erosion
minimum tax under section 59A depends, in part, on the amount of a
taxpayer's deductions.
[[Page 56881]]
Accordingly, the Treasury Department and the IRS estimate that
taxpayers that are subject to both the base erosion minimum tax under
section 59A and section 163(j) are the potential filers of this
election. Using the 2017 SOI tax data, the Treasury Department estimate
that 1,182 firms will make the election. This estimate was determined
by examining three criteria: First, the number of taxpayers subject to
section 59A, namely, C corporations with at least $500,000,000 in gross
receipts, second, the portion of those taxpayers that do not have an
NAICS code associated with a trade or business that is generally not
subject to the section 163(j) limitation (2211 (electric power
generation, transmission and distribution), 2212 (natural gas
distribution), 2213 (water, sewage and other systems), 111 or 112
(farming), 531 (real property)), and, third, the portion of taxpayers
satisfying the first two criteria that received a Form K-1, ``Partner's
Share of Income, Deductions, Credits, etc.''
For the collections of information in proposed Sec. 1.163(j)-7,
namely the CFC and safe-harbor elections, and the corresponding notice
under Sec. 1.964-1(c)(3)(iii), the most recently available 2017 SOI
tax data indicates that, on the high end, the estimated number of
respondents is 4,980 firms. This number was determined by examining,
for the 2017 tax year, Form 1040, Form 1120, Form 1120-S, and Form 1065
filers with greater than $26 million in gross receipts that filed a
Form 5471, Information Return of U.S. Persons With Respect to Certain
Foreign Corporations, where an interest expense amount was reported on
Schedule C of the Form 5471.
The estimated number of respondents that could be subject to the
collection of information for the CFC group or safe-harbor election is
4,980. The estimated annual burden per respondent/recordkeeper varies
from 0 to 30 minutes, depending on individual circumstances, with an
estimated average of 15 minutes. The estimated total annual reporting
and/or recordkeeping burden is 1,245 hours (4,980 respondents x 15
minutes). The estimated annual cost burden to respondents is $95 per
hour. Accordingly, we expect the total annual cost burden for the CFC
group election and safe-harbor election statements to be $118,275
(4,980 * .25 * $95).
The Treasury Department and the IRS request comment on the
assumptions, methodology, and burden estimates related to this
information collection. Comments on the collection of information
should be sent to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503, with copies to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer,
SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of
information should be received by November 2, 2020, which is 60 days
after the date of filing for public inspection with the Office of the
Federal Register.
Comments are specifically requested concerning--
Whether the proposed collection of information is necessary for the
proper performance of the functions of the IRS, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information;
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
II. Regulatory Flexibility Act
It is hereby certified that these Proposed Regulations, if adopted
as final, will not have a significant economic impact on a substantial
number of small entities.
This certification can be made because the Treasury Department and
the IRS have determined that the number of small entities that are
affected as a result of the regulations is not substantial. These rules
do not disincentivize taxpayers from their operations, and any burden
imposed is not significant because the cost of implementing the rules,
if any, is low.
As discussed in the 2018 Proposed Regulations, section 163(j)
provides exceptions for which many small entities will qualify. First,
under section 163(j)(3), the limitation does not apply to any taxpayer,
other than a tax shelter under section 448(a)(3), which meets the gross
receipts test under section 448(c) for any taxable year. A taxpayer
meets the gross receipts test under section 448(c) if the taxpayer has
average annual gross receipts for the 3-taxable year period ending with
the taxable year that precedes the current taxable year that do not
exceed $26,000,000. The gross receipts threshold is indexed annually
for inflation. Because of this threshold, the Treasury Department and
the IRS project that entities with 3-year average gross receipts below
$26 million will not be affected by these regulations except in rare
cases.
Section 163(j) provides that certain trades or businesses are not
subject to the limitation, including the trade or business of
performing services as an employee, electing real property trades or
businesses, electing farming businesses, and certain utilities as
defined in section 163(j)(7)(A)(iv). Under the 2018 Proposed
Regulations, taxpayers that otherwise qualified as real property trades
or businesses or farming businesses that satisfied the small business
exemption in section 448(c) were not eligible to make an election to be
an electing real property trade or business or electing farming
business. Under the Final Regulations, however, those taxpayers are
eligible to make an election to be an electing real property trade or
business or electing farming business. Additionally, the Final
Regulations provide that certain utilities not otherwise excepted from
the limitation can elect for a portion of their non-excepted utility
trade or business to be excepted from the limitation. Any economic
impact on any small entities as a result of the requirements in these
Proposed Regulations, not just the requirements that impose a Paperwork
Reduction Act burden, is not expected to be significant because the
cost of implementing the rules, if any, is low.
The Treasury Department and the IRS do not have readily available
data on the number of filers that are tax shelters, as defined in
section 448(a)(3), that are potentially affected by these provisions.
As described in more detail earlier in this Preamble, these Proposed
Regulations cover several topics, including, but not limited to, debt
financed distributions from passthrough entities, self-charged
interest, the treatment of section 163(j) in relation to trader funds,
the impact of section 163(j) on publicly traded partnerships, and the
application of section 163(j) to United States shareholders of
controlled foreign corporations and to foreign persons with effectively
connected income in the United States.
The Treasury Department and the IRS do not have readily available
data to determine the number of taxpayers affected by rules regarding
self-charged interest because no reporting modules currently connect
these payments by and from partnerships.
The Treasury Department and the IRS likewise do not have precise
data on the
[[Page 56882]]
number of taxpayers affected by rules regarding debt financed
distributions. The Treasury Department and the IRS estimate that the
number of taxpayers affected by the rules regarding debt-financed
distributions is 50,036. This number was reached first by adding the
number of Form 1065 filers that reported code W on line 13b of schedule
K of the Form 1065, or approximately 410,996 using 2018 taxable year
data, and the number of Form 1120-S filers that reported code S on line
12d of schedule K of the Form 1120-S, or approximately 89,367 using
2018 taxable year data. Those codes are used to report interest expense
allocated to debt financed distributions. Using the result of the two
numbers, 500,363 (410,996 + 89,367), produces overly broad results
because the codes referenced above are used to report more than just
interest expense allocated to debt financed distributions. Code W on
line 13b of schedule K of the Form 1065 also is used to report at least
nine other items, including, but not limited to, itemized deductions
that Form 1040 or 1040-SR filers report on Schedule A, soil and water
conservation expenditures, and the domestic productions activities
deductions. Code S on line 12d of schedule K of the Form 1120-S also is
used to report at least eleven other items, including, but not limited
to, itemized deductions that Form 1040 or 1040-SR filers report on
Schedule A, expenditures for the removal of architectural and
transportation barriers for the elderly and disabled that the
corporation elected to treat as a current expense, and film,
television, and live theatrical production expenses. Considering the
number of other items reported under those codes, the Treasury
Department and the IRS estimate that approximately 10% of the filers
using those codes report interest expense allocated to debt financed
distributions (500,363 * 0.10 = 50,036).
Despite not having precise data, these rules do not impose a
significant paperwork or implementation cost burden on taxpayers. Under
Notice 89-35, taxpayers have been required to maintain books and
records to properly report the tax treatment of interest associated
with debt financed acquisitions and contributions by partners, and debt
financed distributions to partners. Additional reporting requirements
are needed to allow passthrough entities and their owners to comply
with the interest tracing rules under Sec. 1.163-8T. Without
additional reporting, the mechanism for determining the tax treatment
of interest under Sec. 1.163-8T is burdensome and unclear. For
example, in some cases, partners would need to report back to the
partnership how they used debt financed distribution to allow the
partnership to properly report its interest expense. This notice of
proposed rules would provide consistent reporting and compliance by
passthrough entities and their owners, which would reduce their overall
burden. The estimated time to determine whether a distribution is a
debt financed distribution and to comply with these rules would be 0
minutes to 30 minutes per taxpayer, depending on individual
circumstances, for an average of 15 minutes. The 2018 monetization
rates for this group of filers is $57.53. According, the Treasury
Department and the IRS estimate the burden to be $719,642.77 (50,036
respondents * 0.25 hours * $57.53).
The Treasury Department and the IRS have determined that, on the
high end, the rules regarding trading partnerships might affect
approximately 309 small entities. This number was reached by
determining, using data for the 2017 taxable year, the number of Form
1065 and Form 1065-B filers, with more than $26 million in gross
receipts, that (1) completed Schedule B to Form 1065 and marked box b,
c, or d in question 1 to denote limited partnership, limited liability
company or limited liability partnership status; (2) have a North
American Industry Classification System (NAICS) code starting with
5231, 5232, 5239 or 5259, and (3) do not have gross receipts exceeding
the small business thresholds for the various NAICS codes. The
following table provides a breakdown of the potentially affected
taxpayers by NAICS code.
------------------------------------------------------------------------
Gross receipts Number of
NAICS code Titles threshold respondents
------------------------------------------------------------------------
5231............. Securities and $41.5M 42
Commodity Contracts
Intermediation and
Brokerage, including
Investment Bank and
Securities Dealing;
Securities
Brokerage; Commodity
Contract Dealing;
Commodity Contracts
Brokerage.
5232............. Securities and 41.5M 0
Commodities
Exchanges.
5239............. Other Financial 41.5M 267
Investment
Activities,
including
Miscellaneous
Intermediation;
Portfolio
Management;
Investment Advice;
Trust, Fiduciary,
and Custody
Activities;
Miscellaneous
Financial Investment
Activities.
5259............. Other Investment 35M [d]
Pools and Funds,
including Open-End
Investment Funds;
Trusts, Estates, and
Agency Accounts;
Other Financial
Vehicles.
------------------------------------------------------
Total 309
Respondents.
------------------------------------------------------------------------
Source: SOI Partnership Study, 2017.
[d] Data is suppressed based on disclosure rules detailed in Publication
1075.
Additionally, the Treasury Department and the IRS have determined
that the rules regarding publicly traded partnerships might affect
approximately 83 taxpayers. This number was reached by determining,
using data for the 2017 taxable year, the number of Form 1065 and 1065-
B filers with gross receipts exceeding $25 million that answered
``yes'' to question 5 on Schedule B to Form 1065 denoting that the
entity is a publicly traded partnership.
As noted earlier, these Proposed Regulations do not impose any new
collection of information on these entities. These Proposed Regulations
actually assist small entities in meeting their filing obligations by
providing definitive advice on which they can rely.
For the section 163(j)(10) elections for passthrough taxpayers
under proposed Sec. Sec. 1.163(j)-6(d)(5) and 1.163(j)-6(g)(4), most
small taxpayers do not need to make the elections because, as discussed
earlier, they are not subject to the section 163(j) limitation. For
small taxpayers that are subject to the
[[Page 56883]]
limitation, the cost to implement the election is low. Pursuant to
Revenue Procedure 2020-22, these passthrough taxpayers simply complete
the Form 8990 as if the election has been made. Accordingly, the burden
of complying with the elections, if needed, is no different than for
taxpayers who do not make the elections.
The persons potentially subject to proposed Sec. 1.163(j)-7 are
U.S. shareholders in one or more CFCs for which BIE is reported, and
that (1) have average annual gross receipts for the 3-taxable year
period ending with the taxable year that precedes the current taxable
year exceeding $26,000,000, and (2) want to make the CFC group election
or safe-harbor election. Proposed Sec. 1.163(j)-7 requires such
taxpayers to attach a statement to their return providing basic
information regarding the CFC group or standalone CFC.
As discussed in the Paperwork Reduction Act section of this
Preamble, the reporting burden for both statements is estimated at 0 to
30 minutes, depending on individual circumstances, with an estimated
average of 15 minutes for all affected entities, regardless of size.
The estimated monetized burden for compliance is $95 per hour.
For these reasons, the Treasury Department and the IRS have
determined that these Proposed Regulations will not have a significant
economic impact on a substantial number of small entities.
Notwithstanding this certification, the Treasury Department and the IRS
invite comments from interested members of the public on both the
number of small entities affected and the economic impact on those
small entities.
E. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 requires
that agencies assess anticipated costs and benefits and take certain
other actions before issuing a final rule that includes any Federal
mandate that may result in expenditures in any one year by a state,
local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. In 2019, that threshold was approximately $154 million.
These Proposed Regulations do not include any Federal mandate that may
result in expenditures by state, local, or tribal governments, or by
the private sector in excess of that threshold.
F. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. These Proposed Regulations do not
have federalism implications and do not impose substantial direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive Order.
Comments and Requests for a Public Hearing
Before these proposed amendments to the regulations are adopted as
final regulations, consideration will be given to comments that are
submitted timely to the IRS as prescribed in the preamble under the
ADDRESSES section. The Treasury Department and the IRS request comments
on all aspects of the proposed regulations. Any electronic comments
submitted, and to the extent practicable any paper comments submitted,
will be made available at www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any
person who timely submits electronic or written comments. Requests for
a public hearing are also encouraged to be made electronically. If a
public hearing is scheduled, notice of the date and time for the public
hearing will be published in the Federal Register. Announcement 2020-4,
2020-17 I.R.B. 667 (April 20, 2020), provides that until further
notice, public hearings conducted by the IRS will be held
telephonically. Any telephonic hearing will be made accessible to
people with disabilities.
Drafting Information
The principal authors of these regulations are Susie Bird, Charles
Gorham, Jaime Park, Joanna Trebat and Sophia Wang (Income Tax &
Accounting), Anthony McQuillen, Adrienne M. Mikolashek, and William
Kostak (Passthroughs and Special Industries), Azeka J. Abramoff
(International), Russell Jones, and John Lovelace (Corporate), and
Pamela Lew, Steven Harrison, and Michael Chin (Financial Institutions &
Products). Other personnel from the Treasury Department and the IRS
participated in their development.
Effect on Other Documents
Notice 89-35, 1989-1 C.B. 675, is proposed to be obsoleted.
Statement of Availability of IRS Documents
IRS Revenue Procedures, Revenue Rulings notices, and other guidance
cited in this document are published in the Internal Revenue Bulletin
(or Cumulative Bulletin) and are available from the Superintendent of
Documents, U.S. Government Publishing Office, Washington, DC 20402, or
by visiting the IRS website at http://www.irs.gov.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.163-14 is added to read as follows:
Sec. 1.163-14 Allocation of interest expense among expenditures--
Passthrough Entities.
(a) In general--(1) Application. This section prescribes rules for
allocating interest expense associated with debt proceeds of a
partnership or S corporation (a passthrough entity). In general,
interest expense on a debt of a passthrough entity is allocated in the
same manner as the debt to which such interest expense relates is
allocated. Debt is allocated by tracing disbursements of the debt
proceeds to specific expenditures. This section prescribes rules for
tracing debt proceeds to specific expenditures of a passthrough entity.
(2) Cross-references. This paragraph provides the general manner in
which interest expense of a passthrough entity is allocated. See
paragraph (b) of this section for the treatment of interest expense
allocated under the rules of this section, paragraph (c) for the manner
in which debt proceeds of a passthrough entity are allocated and the
manner in which interest expense allocated under this section is
treated, paragraph (d) for rules relating to debt allocated under the
rules of Sec. 1.163-8T to distributions to owners of a passthrough
entity, paragraph (e) for rules relating to debt repayments, paragraph
(f) for rules relating to debt allocated under the rules of Sec.
1.163-8T to expenditures for interests in passthrough entities,
paragraph (g) for change of ownership rules for interest expense
allocation
[[Page 56884]]
purposes, and paragraph (h) for examples.
(b) Treatment of interest expense--(1) General rule. Except as
otherwise provided in section Sec. 1.163(j)-8T(m), interest expense
allocated under the rules of this section is treated in the following
manner:
(i) Interest expense allocated to trade or business expenditures
(as defined in paragraph (b)(2)(v) of this section) is taken into
account under section 163(j) by the passthrough entity;
(ii) Interest expense allocated to other trade or business
expenditures (as defined in paragraph (b)(2)(ii) of this section) is
taken into account under the rules of Sec. 1.163-8T, as applicable, by
the passthrough entity owner allocated such interest expense;
(iii) Interest expense allocated to rental expenditures (as defined
in paragraph (b)(2)(iv) of this section) is taken into account under
the rules of Sec. 1.163-8T, as applicable, by the passthrough entity
owner allocated such interest expense;
(iv) Interest expense allocated to investment expenditures (as
defined in paragraph (b)(2)(i) of this section) is taken into account
under the rules of Sec. 1.163-8T, as applicable, by the passthrough
entity owner allocated such interest expense;
(v) Interest expense allocated to personal expenditures (as defined
in paragraph (b)(2)(iii) of this section) is taken into account under
the rules of Sec. 1.163-8T, as applicable, by the passthrough entity
owner allocated such interest expense;
(vi) Interest expense allocated to distributions to owners of a
passthrough entity is taken into account in the manner provided under
paragraph (d) of this section.
(2) Definitions. For purposes of this section--
(i) Investment expenditure means an expenditure defined in Sec.
1.163-8T(b)(3), including any expenditure made with respect to a trade
or business described in section 163(d)(5)(A)(ii) to the extent such
expenditure is properly allocable under section 704(b) to partners that
do not materially participate (within the meaning and for purposes of
section 469) in the trade or business.
(ii) Other trade or business expenditure means an expenditure made
with respect to any activity described in Sec. 1.469-4(b)(1)(ii) and
(iii).
(iii) Personal expenditure means an expenditure (other than a
distribution) not described in paragraphs (b)(2)(i), (ii), (iv) and (v)
of this section.
(iv) Rental expenditure means an expenditure made with respect to
any activity described in Sec. 1.469-4(b)(2) that is not a trade or
business, as defined in Sec. 1.163(j)-1(b)(44).
(v) Trade or business expenditure means an expenditure made with
respect to a trade or business, as defined in Sec. 1.163(j)-1(b)(44),
except for an expenditure made with respect to a trade or business
described in section 163(d)(5)(A)(ii) to the extent such expenditure is
properly allocable under section 704(b) to partners that do not
materially participate (within the meaning and for purposes of section
469) in the trade or business.
(c) Allocation of debt and interest expense. Except as otherwise
provided in this section, the rules of Sec. 1.163-8T apply to
partnerships, S Corporations, and their owners.
(d) Debt allocated to distributions by passthrough entities--(1)
Allocation of distributed debt proceeds--(i) Available expenditures. To
the extent a passthrough entity has available expenditures (as defined
in paragraph (d)(5)(ii) of this section), the passthrough entity shall
first allocate distributed debt proceeds (as defined in paragraph
(d)(5)(iii) of this section) to such available expenditures. If a
passthrough entity has multiple available expenditures, the passthrough
entity shall allocate distributed debt proceeds to such available
expenditures in proportion to the amount of each expenditure.
(ii) Debt financed distributions. If a passthrough entity's
distributed debt proceeds exceeds its available expenditures, the
passthrough entity shall allocate such excess amount of distributed
debt proceeds to distributions to owners of the passthrough entity
(debt financed distributions).
(2) Allocation of interest expense--(i) Interest expense allocated
to debt financed distributions. If distributed debt proceeds are
allocated to distributions to owners of the passthrough entity
(pursuant to paragraph (d)(1)(ii) of this section), the passthrough
entity shall determine the portion of each passthrough entity owner's
allocable interest expense that is debt financed distribution interest
expense. The amount of a passthrough entity owner's debt financed
distribution interest expense equals the lesser of such passthrough
entity owner's allocable interest expense (as defined in paragraph
(d)(5)(i) of this section) or the product of--
(A) The portion of the debt proceeds distributed to that particular
passthrough entity owner; multiplied by
(B) A fraction, the numerator of which is the portion of the
passthrough entity's distributed debt proceeds allocated to debt
financed distributions (determined under paragraph (d)(1)(ii) of this
section), and the denominator of which is the passthrough entity's
total amount of distributed debt proceeds; multiplied by
(C) The distributed debt proceeds interest rate (as defined in
paragraph (d)(5)(iv) of this section).
(ii) Interest expense allocated to available expenditures. If
distributed debt proceeds are allocated to available expenditures
(pursuant to paragraph (d)(1)(i) of this section), the passthrough
entity shall determine the portion of each passthrough entity owner's
allocable interest expense that is expenditure interest expense. The
amount of a passthrough entity owner's expenditure interest expense
equals the product of--
(A) The portion of the passthrough entity's distributed debt
proceeds allocated to available expenditures (determined under
paragraph (d)(1)(i) of this section); multiplied by
(B) The distributed debt proceeds interest rate; multiplied by
(C) A fraction, the numerator of which is the excess of that
particular passthrough entity owner's allocable interest expense over
its debt financed distribution interest expense (determined under
paragraph (d)(2)(i) of this section) (remaining interest expense), and
the denominator of which is aggregate of all the passthrough owners'
remaining interest expense amounts.
(iii) Excess interest expense. To the extent a passthrough entity
owner's allocable interest expense is not treated as either debt
financed distribution interest expense (determined under paragraph
(d)(2)(i) of this section) or expenditure interest expense (determined
under paragraph (d)(2)(ii) of this section), such allocable interest
expense is excess interest expense.
(3) Tax treatment of interest expense--(i) Debt financed
distribution interest expense. The tax treatment of a passthrough
entity owner's debt financed distribution interest expense (determined
under paragraph (d)(2)(i) of this section), if any, shall be determined
by the passthrough entity owner under the rules of Sec. 1.163-8T, as
applicable, in accordance with such passthrough entity owner's use of
its portion of the passthrough entity's distributed debt proceeds. The
passthrough entity shall separately state the amount of each owner's
debt financed distribution interest expense. Debt financed distribution
interest expense is not treated as interest expense of the entity for
purposes of this section.
[[Page 56885]]
(ii) Expenditure interest expense. The tax treatment of a
passthrough entity owner's expenditure interest expense (determined
under paragraph (d)(2)(ii) of this section), if any, shall be
determined based on how the distributed debt proceeds were allocated
among available expenditures (pursuant to paragraph (d)(1)(i) of this
section). For example, if distributed debt proceeds are allocated to a
rental activity under paragraph (d)(1)(i) of this section, the interest
expense associated with such debt should be taken into account by the
passthrough entity in computing income or loss from the rental activity
that is reported to the owner.
(iii) Excess interest expense. The tax treatment of a passthrough
entity owner's excess interest expense (determined under paragraph
(d)(2)(iii) of this section), if any, shall be determined by allocating
the distributed debt proceeds among all the assets of the passthrough
entity, pro-rata, based on the adjusted basis of such assets. For
purposes of the preceding sentence, the passthrough entity shall use
either the adjusted tax bases of its assets reduced by any debt of the
passthrough entity allocated to such assets, or determine its adjusted
basis in its assets in accordance with the rules in Sec. 1.163(j)-
10(c)(5)(i), reduced by any debt of the passthrough entity allocated to
such assets. Once a passthrough entity chooses a method for determining
its adjusted basis in its assets for this purpose, the passthrough
entity must consistently apply the same method in all subsequent tax
years. Any assets purchased in the same taxable year as the
distribution (such that the expenditure for those assets was taken into
account in Sec. 1.163-14(b)(1)) are not included in this allocation.
(4) Treatment of transfers of interests in a passthrough entity by
an owner that received a debt financed distribution--(i) In general. In
the case of a transfer of an interest in a passthrough entity, any debt
financed distribution interest expense of the transferor shall be
treated as excess interest expense by the transferee. However, in the
case of a transfer of an interest in a passthrough entity to a person
who is related to the transferor, any debt financed distribution
interest expense of the transferor shall continue to be treated as debt
financed distribution interest expense by the related party transferee,
and the tax treatment of such debt financed distribution expense under
paragraph (d)(3) of this section shall be the same to the related party
transferee as it was to the transferor. The term related party means
any person who bears a relationship to the taxpayer which is described
in section 267(b) or 707(b)(1).
(ii) Anti-avoidance rule. Arrangements entered into with a
principal purpose of avoiding the rules of this paragraph, including
the transfer of an interest in a passthrough entity by an owner who
treated a portion of its allocable interest expense as debt financed
distribution interest expense to an unrelated party pursuant to a plan
to transfer the interest back to the owner who received the debt
financed distribution interest expense or to a party who is related to
the owner who received the debt financed distribution interest expense,
may be disregarded or recharacterized by the Commissioner of the IRS to
the extent necessary to carry out the purposes of this paragraph.
(5) Definitions. For purposes of this paragraph--
(i) Allocable interest expense means a passthrough entity owner's
share of interest expense associated with the distributed debt proceeds
allocated under section 704 or section 1366(a).
(ii) Available expenditure means an expenditure of a passthrough
entity described in paragraph (b)(2) of this section made in the same
taxable year of the entity as the distribution, to the extent that debt
proceeds (including other distributed debt proceeds) are not otherwise
allocated to such expenditure.
(iii) Distributed debt proceeds means debt proceeds of a
passthrough entity that are allocated under Sec. 1.163-8T and this
section to distributions to owners of the passthrough entity in a
taxable year. If debt proceeds from multiple borrowings are allocated
under Sec. 1.163-8T to distributions to owners of the passthrough
entity in a taxable year, then all such borrowings are treated as a
single borrowing for purposes of this section.
(iv) Distributed debt proceeds interest rate means a fraction, the
numerator of which is the amount of interest expense associated with
distributed debt proceeds, and the denominator of which is the amount
of distributed debt proceeds.
(e) Repayment of passthrough entity debt--(1) In general. If any
portion of passthrough entity debt is repaid at a time when such debt
is allocated to more than one expenditure, the debt is treated for
purposes of this section as repaid in the following order:
(i) Amounts allocated to one or more expenditures described in
paragraph (b)(2)(iii);
(ii) Amounts allocated to one or more expenditures described in
paragraph (b)(2)(i) (relating to investment expenditures as defined in
Sec. 1.163-8T(b)(3));
(iii) Amounts allocated to one or more expenditures described in
paragraphs (b)(2)(ii) and (iv) (relating to expenditures with respect
to any activities described in Sec. 1.469-4(b)(1)(ii) and (iii), and
Sec. 1.469-4(b)(2)); and
(iv) Amounts allocated to one or more expenditures described in
paragraph (b)(2)(v) (generally relating to expenditures made with
respect to a trade or business as defined in Sec. 1.163(j)-1(b)(44)).
(2) Repayment of debt used to finance a distribution. Any repayment
of debt of a passthrough entity that has been allocated to debt
financed distributions under paragraph (d)(1)(ii) of this section and
to one or more available expenditures under paragraph (d)(1)(i) of this
section may, at the option of the passthrough entity, be treated first
as a repayment of the portion of the debt that had been allocated to
such debt financed distributions.
(f) Debt allocated to expenditures for interests in passthrough
entities. In the case of debt proceeds allocated under the rules of
Sec. 1.163-8T and this section to contributions to the capital of or
to the purchase of an interest in a passthrough entity, the character
of the debt proceeds and any associated interest expense shall be
determined by allocating the debt proceeds among the adjusted tax bases
of the entity's assets. For purposes of this paragraph, the owner must
allocate the debt proceeds either in proportion to the relative
adjusted tax basis of the entity's assets reduced by any debt allocated
to such assets, or based on the adjusted basis of the entity's assets
in accordance with the rules in Sec. 1.163(j)-10(c)(5)(i) reduced by
any debt allocated to such assets. Once the owner chooses a method for
allocating the debt proceeds for this purpose, the owner must
consistently apply the same method in all subsequent tax years.
Individuals shall report interest expense paid or incurred in
connection with debt-financed acquisitions on their individual income
tax return in accordance with the asset to which the interest expense
is allocated under this paragraph.
(g) Change in ownership. Any transfer of an ownership interest in a
passthrough entity is not a reallocation event for purposes of Sec.
1.163-8T(j), except as provided for in paragraph (d)(4) of this
section.
(h) Examples--(1) Example 1--(i) Facts. A (an individual) and B
(an individual) are partners in partnership PRS. PRS conducts two
businesses; a manufacturing business, which is a trade or business
as defined in Sec. 1.163(j)-1(b)(44) (manufacturing), and a
separate commercial real estate leasing
[[Page 56886]]
business, which is an activity described in Sec. 1.469-4(b)(2)
(leasing). In Year 1, PRS borrowed $100,000 from an unrelated third-
party lender (the loan). Other than the loan, PRS does not have any
outstanding debt. During Year 1, PRS paid $80,000 in manufacturing
expenses, $120,000 in leasing expenses, and made a $100,000
distribution to A, the proceeds of which A used to make a personal
expenditure. Under Sec. 1.163-8T, PRS treated the $100,000 of loan
proceeds as having been distributed to A. As a result, in Year 1 PRS
had $200,000 of available expenditures (as defined in paragraph
(d)(5)(ii) of this section) and $100,000 of distributed debt
proceeds (as defined in paragraph (d)(5)(iii) of this section). PRS
paid $10,000 in interest expense that accrued during Year 1 on the
loan, and allocated such interest expense under section 704(b)
equally to A and B ($5,000 each). Thus, A and B each had $5,000 of
allocable interest expense (as defined in paragraph (d)(5)(i) of
this section).
(ii) Applicability. Because PRS treated all $100,000 of the loan
proceeds as having been distributed under Sec. 1.163-8T, PRS
allocated all $10,000 of the interest expense associated with the
loan to the distribution. Thus, pursuant to paragraph (b)(1)(vi) of
this section, PRS must determine the tax treatment of such $10,000
of interest expense in the manner provided in paragraph (d) of this
section.
(iii) Debt allocated to distributions. Under paragraph (d)(1)(i)
of this section, to the extent PRS has available expenditures (as
defined under paragraph (d)(5)(ii) of this section), it must
allocate any distributed debt proceeds (as defined under paragraph
(d)(5)(iii) of this section) to such available expenditures. Here,
PRS has distributed debt proceeds of $100,000 and available
expenditures of $200,000 (manufacturing expenditures of $80,000,
plus leasing expenditures of $120,000). Thus, PRS allocates all
$100,000 of the distributed debt proceeds to available expenditures
as follows: $40,000 to manufacturing expenditures ($100,000 x
($80,000/$200,000)) and $60,000 to leasing expenditures ($100,000 x
($120,000/$200,000)). Because the amount of PRS's distributed debt
proceeds is less than its available expenditures, none of the
distributed debt proceeds are allocated to debt financed
distributions pursuant to paragraph (d)(1)(ii) of this section.
(iv) Allocation of interest expense. Because all of PRS's
distributed debt proceeds are allocated to available expenditures
(pursuant to paragraph (d)(1)(i) of this section), A and B each
treat all $5,000 of their allocable interest expense as expenditure
interest expense.
(v) Tax treatment of interest expense. Pursuant to paragraph
(d)(3)(ii) of this section, each partner treats its expenditure
interest expense (determined under paragraph (d)(2)(ii) of this
section) in the same manner as the distributed debt proceeds that
were allocated to available expenditures under paragraph (d)(1)(i)
of this section. Thus, A's $5,000 of expenditure interest expense
comprises of $2,000 of business interest expense ($5,000 x ($40,000/
$100,000)) and $3,000 of interest expense allocated to rental
expenditures ($5,000 x ($60,000/$100,000)). B's $5,000 of
expenditure interest expense similarly comprises of $2,000 of
business interest expense and $3,000 of interest expense allocated
to rental expenditures. As a result, $4,000 of interest expense
associated with the distributed debt proceeds (A's $2,000 plus B's
$2,000 of expenditure interest expense treated as business interest
expense) is business interest expense of PRS, subject to section
163(j) at the PRS level.
Table 1 to Paragraph (h)(2)(vii)
------------------------------------------------------------------------
Partner A Partner B
------------------------------------------------------------------------
Allocable interest expense:
Debt financed distribution interest
expense:
N/A............................. $0 $0
Expenditure interest expense:
Business interest (to PRS)...... 2,000 2,000
Rental activity interest expense 3,000 3,000
Excess interest expense:
N/A............................. 0 0
-------------------------------
Total....................... 5,000 5,000
------------------------------------------------------------------------
(2) Example 2--(i) Facts. The facts are the same as in Example 1
in paragraph (h)(1)(i) of this section, except PRS did not have any
rental expenditures in Year 1. As a result, in Year 1 PRS had
$80,000 of available expenditures (as defined in paragraph
(d)(5)(ii) of this section) and $100,000 of distributed debt
proceeds (as defined in paragraph (d)(5)(iii) of this section).
(ii) Applicability. Because PRS treated all $100,000 of the loan
proceeds as having been distributed to A under Sec. 1.163-8T, PRS
allocated all $10,000 of the interest expense associated with the
loan to the distribution. Thus, pursuant to paragraph (b)(1)(vi) of
this section, PRS must determine the tax treatment of such $10,000
of interest expense in the manner provided in paragraph (d) of this
section.
(iii) Debt allocated to distributions. Under paragraph (d)(1)(i)
of this section, to the extent PRS has available expenditures (as
defined under paragraph (d)(5)(ii) of this section), it must
allocate any distributed debt proceeds (as defined under paragraph
(d)(5)(i) of this section) to such available expenditures. Here, PRS
has distributed debt proceeds of $100,000 and available expenditures
of $80,000. Thus, $80,000 of the distributed debt proceeds are
allocated to such available expenditures. Pursuant to paragraph
(d)(1)(ii) of this section, PRS allocates the remaining $20,000 of
the distributed debt proceeds to debt financed distributions.
(iv) Allocation of interest expense--debt financed distribution
interest expense. Pursuant to paragraph (d)(2)(i) of this section, A
treats $2,000 of its allocable interest expense as debt financed
distribution interest expense, which is the lesser of $5,000 or
$2,000 ((A) the portion of debt proceeds distributed to A
($100,000), multiplied by (B) a fraction, the numerator of which is
the portion of PRS's distributed debt proceeds allocated to debt
financed distributions pursuant to paragraph (d)(1)(ii) of this
section ($20,000), and the denominator of which is PRS's total
amount of distributed debt proceeds ($100,000), multiplied by (C)
the distributed debt proceeds interest rate, as defined in paragraph
(d)(5)(iii) of this section, of 10% (the amount of interest expense
associated with distributed debt proceeds ($10,000), divided by the
amount of distributed debt proceeds ($100,000))) and B treats $0 of
its allocable interest expense as debt financed distribution
interest expense, which is the lesser of $5,000 or $0 ((A) $0 x (B)
20% x (C) 10%).
BILLING CODE 4830-01-P
[[Page 56887]]
[GRAPHIC] [TIFF OMITTED] TP14SE20.010
(v) Allocation of interest expense--expenditure interest
expense. Pursuant to paragraph (d)(2)(ii) of this section, A treats
$3,000 of its allocable interest expense as expenditure interest
expense ((A) the portion of PRS's distributed debt proceeds
allocated to available expenditures pursuant to paragraph (d)(1)(i)
of this section ($80,000), multiplied by (B) the distributed debt
proceeds interest rate (10%), multiplied by (C) a fraction, the
numerator of which is A's remaining interest expense (that is, the
excess of A's allocable interest expense ($5,000) over its debt
financed distribution interest expense as determined under paragraph
(d)(2)(i) of this section ($2,000)), and the denominator of which is
the aggregate of A's and B's remaining interest expense amounts
($3,000 + $5,000)) and B treats $5,000 of its allocable interest
expense as expenditure interest expense ((A) $80 x (B) 10% x (C)
62.5%).
[[Page 56888]]
[GRAPHIC] [TIFF OMITTED] TP14SE20.011
(vi) Allocation of interest expense--excess interest expense.
Neither partner treats any of its allocable interest expense as
excess interest expense under paragraph (d)(2)(iii) of this section.
(vii) Tax treatment of interest expense. Pursuant to paragraph
(d)(3)(i) of this section, each partner determines the tax treatment
of its debt financed distribution interest expense (determined under
paragraph (d)(2)(i) of this section) based on its use of the
distributed debt proceeds. Because A used its $100,000 of
distributed debt proceeds on a personal expenditure, A's $2,000 of
debt financed distribution interest expense is personal interest
subject to section 163(h) at A's level. Pursuant to paragraph
(d)(3)(ii) of this section, each partner treats its expenditure
interest expense (determined under paragraph (d)(2)(ii) of this
section) in the same manner as the distributed debt proceeds that
were allocated to available expenditures under paragraph (d)(1)(i)
of this section. Thus, all $3,000 of A's expenditure interest
expense and all $5,000 of B's expenditure interest expense is
business interest expense. As a result, $8,000 interest expense
associated with the distributed debt proceeds (A's $3,000 plus B's
$5,000 of expenditure interest expense treated as business interest
expense) is business interest expense of PRS, subject to section
163(j) at the PRS level.
Table 6 to Paragraph (h)(2)(vii)
------------------------------------------------------------------------
Partner A Partner B
------------------------------------------------------------------------
Allocable interest expense;
Debt financed distribution interest
expense:
Personal interest............... $2,000 $0
Expenditure interest expense:
Business interest (to PRS)...... 3,000 5,000
Excess interest expense:
N/A............................. 0 0
-------------------------------
Total....................... 5,000 5,000
------------------------------------------------------------------------
[[Page 56889]]
(3) Example 3--(i) Facts. The facts are the same as in Example 2
in paragraph (h)(2)(i) of this section, except PRS paid $20,000 in
manufacturing expenses, made a distribution of $75,000 to A (the
proceeds of which A used on a personal expenditure), and made a
distribution of $25,000 to B (the proceeds of which B used on a
trade or business expenditure). As a result, in Year 1 PRS had
$20,000 of available expenditures (as defined in paragraph
(d)(5)(ii) of this section) and $100,000 of distributed debt
proceeds (as defined in paragraph (d)(5)(iii) of this section). The
$20,000 manufacturing expenditure was to acquire assets used in
PRS's manufacturing business. At the end of Year 1, the adjusted tax
basis of PRS's assets used in manufacturing was $720,000 and the
adjusted tax basis of PRS's assets used in leasing was $200,000. In
addition, at the end of Year 1, the adjusted basis of PRS's assets
held for investment (within the meaning of section 163(d)(5)) was
$100,000.
(ii) Applicability. Because PRS treated all $100,000 of the loan
proceeds as having been distributed under Sec. 1.163-8T, PRS
allocated all $10,000 of the interest expense associated with the
loan to the distribution. Thus, pursuant to paragraph (b)(1)(vi) of
this section, PRS must determine the tax treatment of such $10,000
of interest expense in the manner provided in paragraph (d) of this
section.
(iii) Debt allocated to distributions. Under paragraph (d)(1)(i)
of this section, to the extent PRS has available expenditures (as
defined under paragraph (d)(5)(ii) of this section), it must
allocate any distributed debt proceeds (as defined under paragraph
(d)(5)(i) of this section) to such available expenditures. Here, PRS
has distributed debt proceeds of $100,000 and available expenditures
of $20,000. Thus, PRS allocates $20,000 of the distributed debt
proceeds to available expenditures. Pursuant to paragraph (d)(1)(ii)
of this section, PRS allocates the remaining $80,000 of distributed
debt proceeds to debt financed distributions.
(iv) Allocation of interest expense--debt financed distribution
interest expense. Pursuant to paragraph (d)(2)(i) of this section, A
treats $5,000 of its allocable interest expense as debt financed
distribution interest expense, which is the lesser of $5,000 or
$6,000 ((A) $75,000 x (B) 80% x (C) 10%) and B treats $2,000 of its
allocable interest expense as debt financed distribution interest
expense, which is the lesser of $5,000 or $2,000 ((A) $25,000 x (B)
80% x (C) 10%).
[GRAPHIC] [TIFF OMITTED] TP14SE20.012
(v) Allocation of interest expense--expenditure interest
expense. Pursuant to paragraph (d)(2)(ii) of this section, A does
not treat any of its allocable interest expense as expenditure
interest expense ((A) $20,000 x (B) 10% x (C) 0%) and B treats
$2,000 of its allocable interest expense as expenditure interest
expense ((A) $20,000 x (B) 10% x (C) 100%).
[[Page 56890]]
[GRAPHIC] [TIFF OMITTED] TP14SE20.013
BILLING CODE 4830-01-C
(vi) Allocation of interest expense--excess interest expense.
Pursuant to paragraph (d)(2)(iii) of this section, A does not treat
any of its allocable interest expense as excess interest expense
($5,000 of allocable interest expense, less $5,000 of debt financed
distribution interest expense, less $0 of expenditure interest
expense) and B treats $1,000 of its allocable interest expense as
excess interest expense ($5,000 of allocable interest expense, less
$2,000 of debt financed distribution interest expense, less $2,000
of expenditure interest expense).
(vii) Tax treatment of interest expense. Pursuant to paragraph
(d)(3)(i) of this section, each partner determines the tax treatment
of its debt financed distribution interest expense based on its use
of the distributed debt proceeds. A used its share of the
distributed debt proceeds to make personal expenditures. Thus, A's
$5,000 of debt financed distribution interest expense is subject to
section 163(h) at A's level. B used its share of the distributed
debt proceeds to make trade or business expenditures. Thus, B's
$2,000 of debt financed distribution interest expense is subject to
section 163(j) at B's level. Pursuant to paragraph (d)(3)(ii) of
this section, B treats its $2,000 of expenditure interest expense in
the same manner as the distributed debt proceeds were allocated to
available expenditures under paragraph (d)(1)(i) of this section.
Thus, B's $2,000 of expenditure interest expense is business
interest expense, subject to section 163(j) at the level of PRS.
Pursuant to paragraph (d)(3)(iii) of this section, B determines the
tax treatment of its $1,000 of excess interest expense by allocating
distributed debt proceeds among the adjusted basis of PRS's assets,
reduced by any debt allocated to such assets. For purposes of
paragraph (d)(3)(iii) of this section, PRS's has $700,000 ($720,000-
$20,000 debt proceeds allocated to such assets) of basis in its
manufacturing assets, $200,000 of basis in its leasing assets, and
$100,000 of basis in its assets held for investment. Thus, B's
$1,000 of excess interest expense is treated as $700 of business
interest expense subject to 163(j) at the PRS level, $200 of
interest expense related to a rental activity, and $100 of
investment interest expense.
Table 11 to Paragraph (h)(3)(vii)
------------------------------------------------------------------------
Partner A Partner B
------------------------------------------------------------------------
Allocable interest expense:
Debt financed distribution interest
expense:
Personal interest:.............. $5,000 $0
Business interest (but not to 0 2,000
PRS)...........................
[[Page 56891]]
Expenditure interest expense:
Business interest (to PRS)...... 0 2,000
Excess interest expense:
Business interest (to PRS):..... 0 700
Rental activity interest expense 0 200
Investment interest expense..... 0 100
-------------------------------
Total....................... 5,000 5,000
------------------------------------------------------------------------
(4) Example 4. The facts are the same as in Example 2 in
paragraph (h)(2)(i) of this section. In Year 2, A sells its interest
in PRS to C. C is not related to either A or B under the rules of
either section 267(b) or section 707(b)(1). No facts have changed
with respect to PRS's loan. Under these facts, and only for purposes
of this section, C's share of the debt financed distribution
interest expense will be treated as excess interest expense pursuant
to paragraph (d)(4)(i) of this section. Accordingly, C will
determine the character of its share of this interest expense by
allocating the debt proceeds associated with this interest expense
among the assets of PRS under paragraph (d)(3)(iii) of this section.
(5) Example 5. The facts are the same as in Example 4 in
paragraph (h)(4) of this section, except that C is a party that is
related to A under the rules of either section 267(b) or section
707(b)(1). Under these facts, and only for purposes of this section,
A's $2,000 of debt financed distribution interest expense shall,
pursuant to paragraph (d)(4)(i) of this section, continue to be
treated as debt financed distribution interest expense of C, subject
to the same tax treatment as it was to the transferor (personal
interest expense).
(6) Example 6. The facts are the same as in Example 2 in
paragraph (h)(2)(i) of this section, except that in Year 2 B sells
its interest in PRS to D. D is not related to either A or B under
the rules of either section 267(b) or section 707(b)(1). No other
facts have changed with respect to PRS's loan. Under these facts,
the tax treatment of the expenditure interest expense does not
change with respect to PRS or any of the partners as a result of the
ownership change pursuant to paragraph (g) of this section.
Accordingly, the tax treatment of the expenditure interest expense
allocable to D under section 704(b) is identical to the expenditure
interest expense that had been allocable to B prior to the sale.
(7) Example 7--(i) Facts. A (an individual) and B (an
individual) are equal shareholders in S corporation X. X conducts a
manufacturing business, which is a trade or business as defined in
Sec. 1.163(j)-1(b)(44) (manufacturing). In Year 1, X borrowed
$100,000 from an unrelated third-party lender (the loan). Other than
the loan, X does not have any outstanding debt. During Year 1, X
paid $100,000 in manufacturing expenses and made a $50,000
distribution to each of its shareholders, A and B, which each
shareholder used to make a personal expenditure. Under Sec. 1.163-
8T, X treated all $100,000 of the loan proceeds as having been
distributed to A and B. As a result, in Year 1 X had $100,000 of
available expenditures (as defined in paragraph (d)(5)(ii) of this
section) and $100,000 of distributed debt proceeds (as defined in
paragraph (d)(5)(iii) of this section). X paid $10,000 in interest
expense that accrued during Year 1 on the loan, and allocated such
interest expense under section 1366(a) equally to A and B ($5,000
each). Thus, A and B each had $5,000 of allocable interest expense
(as defined in paragraph (d)(5)(i) of this section).
(ii) Applicability. Because X treated all $100,000 of the loan
proceeds as having been distributed to A and B under Sec. 1.163-8T,
PRS allocated all $10,000 of the interest expense associated with
the loan to the distributions. Thus, pursuant to paragraph
(b)(1)(vi) of this section, PRS must determine the tax treatment of
such $10,000 of interest expense in the manner provided in paragraph
(d) of this section.
(iii) Debt allocated to distributions. Under paragraph (d)(1)(i)
of this section, to the extent X has available expenditures (as
defined under paragraph (d)(5)(ii) of this section), it must
allocate any distributed debt proceeds (as defined under paragraph
(d)(5)(iii) of this section) to such available expenditures. Here, X
has distributed debt proceeds of $100,000 and available expenditures
of $100,000. Thus, PRS allocates all $100,000 of the distributed
debt proceeds to available expenditures
(iv) Allocation of interest expense. Because all of X's
distributed debt proceeds are allocated to available expenditures
(pursuant to paragraph (d)(1)(i) of this section), A and B each
treat all $5,000 of their allocable interest expense as expenditure
interest expense.
(v) Tax treatment of interest expense. Pursuant to paragraph
(d)(3)(ii) of this section, each partner treats its expenditure
interest expense (determined under paragraph (d)(2)(ii) of this
section) in the same manner as the distributed debt proceeds that
were allocated to available expenditures under paragraph (d)(1)(i)
of this section. Thus, A's $5,000 of expenditure interest expense
and B's $5,000 of expenditure interest expense is treated as
business interest expense of X, subject to section 163(j) at X's
level.
Table 12 to Paragraph (h)(7)(v)
------------------------------------------------------------------------
Partner A Partner B
------------------------------------------------------------------------
Allocable interest expense:
Debt financed distribution interest
expense:
N/A............................. $0 $0
Expenditure interest expense:
Business interest (to X)........ 5,000 5,000
Excess interest expense:
N/A............................. 0 0
-------------------------------
Total....................... 5,000 5,000
------------------------------------------------------------------------
(h) Applicability date. This section applies to taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER]. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, and before [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER], provided
that they consistently apply the rules of this
[[Page 56892]]
section to that taxable year and each subsequent taxable year.
0
Par. 3. Section 1.163-15 is added to read as follows:
Sec. 1.163-15 Debt Proceeds Distributed from Any Taxpayer Account or
from Cash.
(a) In general. Regardless of paragraphs (c)(4) and (5) of Sec.
1.163-8T, in the case of debt proceeds deposited in an account, a
taxpayer that is applying Sec. 1.163-8T or Sec. 1.163-14 may treat
any expenditure made from any account of the taxpayer, or from cash,
within 30 days before or 30 days after debt proceeds are deposited in
any account of the taxpayer as made from such proceeds to the extent
thereof. Similarly, in the case of debt proceeds received in cash, a
taxpayer that is applying Sec. 1.163-8T or Sec. 1.163-14 may treat
any expenditure made from any account of the taxpayer, or from cash,
within 30 days before or 30 days after debt proceeds are received in
cash as made from such proceeds to the extent thereof. For purposes of
this section, terms used have the same meaning as in Sec. 1.163-
8T(c)(4) and (5).
(b) Applicability date. This section applies to taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER]. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of this section to a taxable year
beginning after December 31, 2017, and before [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER], provided
that they consistently apply the rules of this section to that taxable
year and each subsequent taxable year.
0
Par. 4. As added in a final rule published elsewhere in this issue of
the Federal Register, effective November 13, 2020, Sec. 1.163(j)-0 is
amended by:
0
1. Revising the entries for Sec. 1.163(j)-1(b)(1)(iv)(B),
(b)(22)(iii)(F), and (b)(35);
0
2. Adding entries for Sec. Sec. 1.163(j)-1(b)(1)(iv)(E), (c)(4), and
(c)(4)(i) and (ii);
0
3. Adding an entry for Sec. 1.163(j)-2(d)(3);
0
4. Revising the entries for Sec. Sec. 1.163(j)-2(k) and 1.163(j)-
6(c)(1) and (2);
0
5. Adding an entry for Sec. 1.163(j)-6(d)(3), (4), and (5) and (e)(5);
0
6. Revising the entries for Sec. Sec. 1.163(j)-6(f)(1)(iii), (g)(4),
(h)(4) and (5), (j), and (n) and 1.163(j)-7;
0
7. Adding an entry for Sec. 1.163(j)-8;
0
8. Revising the entries for Sec. 1.163(j)-10(c)(5)(ii)(D) and (f).
The revisions and additions read as follows:
Sec. 1.163(j)-0 Table of Contents.
* * * * *
Sec. 1.163(j)-1 Definitions.
* * * * *
(b) * * *
(1) * * *
(iv) * * *
(B) Deductions by members of a consolidated group.
(1) In general.
(2) Application of the alternative computation method.
* * * * *
(E) Alternative computation method.
(1) Alternative computation method for property dispositions.
(2) Alternative computation method for dispositions of member
stock.
(3) Alternative computation method for dispositions of
partnership interests.
* * * * *
(22) * * *
(iii) * * *
(F) Section 163(j) interest dividends.
(1) In general.
(2) Limitation on amount treated as interest income.
(3) Conduit amounts.
(4) Holding period.
(5) Exception to holding period requirement for money market
funds and certain regularly declared dividends.
* * * * *
(35) Section 163(j) interest dividend.
(i) In general.
(ii) Reduction in the case of excess reported amounts.
(iii) Allocation of excess reported amount.
(A) In general.
(B) Special rule for noncalendar year RICs.
(iv) Definitions.
(A) Reported section 163(j) interest dividend amount.
(B) Excess reported amount.
(C) Aggregate reported amount.
(D) Post-December reported amount.
(E) Excess section 163(j) interest income.
(v) Example.
* * * * *
(c) * * *
* * * * *
(4) Alternative computation for certain adjustments to tentative
taxable income, and section 163(j) interest dividends.
(i) Alternative computation for certain adjustments to tentative
taxable income.
(ii) Section 163(j) interest dividends.
* * * * *
Sec. 1.163(j)-2 Deduction for business interest expense limited.
* * * * *
(b) * * *
* * * * *
(3) * * *
* * * * *
(iii) Transactions to which section 381 applies.
(iv) Consolidated groups.
* * * * *
(d) * * *
* * * * *
(3) Determining a syndicate's loss amount.
* * * * *
(k) Applicability dates.
(1) In general.
(2) Paragraphs (b)(iii), (b)(iv), and (d)(3).
Sec. 1.163(j)-6 Application of the business interest deduction
limitation to partnerships and subchapter S Corporations
* * * * *
(c) * * *
(1) Modification of business interest income for partnerships.
(2) Modification of business interest expense for partnerships.
* * * * *
(d) * * *
* * * * *
(3) Section 743(b) adjustments and publicly traded partnerships.
(4) Modification of adjusted taxable income for partnerships.
(5) Election to use 2019 adjusted taxable income for taxable
years beginning in 2020.
* * * * *
(e) * * *
* * * * *
(5) Partner basis items, remedial items, and publicly traded
partnerships.
(6) Partnership deductions capitalized by a partner.
* * * * *
(f) * * *
(1) * * *
(iii) Exception applicable to publicly traded partnerships.
* * * * *
(g) * * *
(4) Special rule for taxable years beginning in 2019 and 2020.
* * * * *
(h) * * *
(4) Partner basis adjustments upon liquidating distribution.
(5) Partnership basis adjustments upon partner dispositions.
* * * * *
(j) Tiered partnerships.
(1) Purpose.
(2) Section 704(b) capital account adjustments.
(3) Basis adjustments of upper-tier partnership.
(4) Treatment of excess business interest expense allocated by
lower-tier partnership to upper-tier partnership.
(5) UTP EBIE conversion events.
(i) Allocation to upper-tier partnership by lower-tier
partnership of excess taxable income (or excess business interest
income).
(ii) Upper-tier partnership disposition of lower-tier
partnership interest.
(6) Disposition of specified partner's partnership interest.
(i) General rule.
(ii) Special rules.
(A) Distribution in liquidation of a specified partner's
partnership interest.
(B) Contribution of a specified partner's partnership interest.
(7) Effect of basis adjustments allocated to UTP EBIE.
(i) In general.
[[Page 56893]]
(ii) UTP EBIE treated as deductible business interest expense.
(iii) UTP EBIE treated as excess business interest expense.
(iv) UTP EBIE reduced due to a disposition.
(8) Anti-loss trafficking.
(i) Transferee specified partner.
(ii) UTP EBIE without a specified partner.
(iii) Disallowance of addback.
(9) Determining allocable ATI and allocable business interest
income of upper-tier partnership partners.
(i) In general.
(ii) Upper-tier partner's allocable ATI.
(iii) Upper-tier partner's allocable business interest income.
(l) * * *
* * * * *
(4) * * *
(iv) S corporation deductions capitalized by an S corporation
shareholder.
* * * * *
(n) Treatment of self-charged lending transactions between
partnerships and partners.
(o) * * *
* * * * *
Sec. 1.163(j)-7 Application of the section 163(j) limitation to
foreign corporations and United States shareholders.
(a) Overview.
* * * * *
(c) Application of section 163(j) to CFC group members of a CFC
group.
(1) Scope.
(2) Calculation of section 163(j) limitation for a CFC group for
a specified period.
(i) In general.
(ii) Certain transactions between CFC group members disregarded.
(iii) CFC group treated as a single C corporation for purposes
of allocating items to an excepted trade or business.
(iv) CFC group treated as a single taxpayer for purposes of
determining interest.
(3) Deduction of business interest expense.
(i) CFC group business interest expense.
(A) In general.
(B) Modifications to relevant terms.
(ii) Carryforwards treated as attributable to the same taxable
year.
(iii) Multiple specified taxable years of a CFC group member
with respect to a specified period.
(iv) Limitation on pre-group disallowed business interest
expense carryforward.
(A) General rule.
(1) CFC Group member pre-group disallowed business interest
expense carryforward.
(2) Subgrouping.
(B) Deduction of pre-group disallowed business interest expense
carryforwards.
(4) Currency translation.
(5) Special rule for specified periods beginning in 2019 or
2020.
(i) 50 percent ATI limitation applies to a specified period of a
CFC group.
(ii) Election to use 2019 ATI applies to a specified period of a
CFC group.
(A) In general.
(B) Specified taxable years that do not begin in 2020.
(d) Determination of a specified group and specified group
members.
(1) Scope.
(2) Rules for determining a specified group.
(i) Definition of a specified group.
(ii) Indirect ownership.
(iii) Specified group parent.
(iv) Qualified U.S. person.
(v) Stock.
(vi) Options treated as exercised.
(vii) When a specified group ceases to exist.
(3) Rules for determining a specified group member.
(e) Rules and procedures for treating a specified group as a CFC
group.
(1) Scope.
(2) CFC group and CFC group member.
(i) CFC group.
(ii) CFC group member.
(3) Duration of a CFC group.
(4) Joining or leaving a CFC group.
(5) Manner of making or revoking a CFC group election.
(i) In general.
(ii) Revocation by election.
(iii) Timing.
(iv) Election statement.
(v) Effect of prior CFC group election.
(f) Treatment of a CFC group member that has ECI.
(1) In general.
(2) Ordering rule.
(g) * * *
* * * * *
(3) Treatment of certain taxes.
(4) Anti-abuse rule.
(i) In general.
(ii) ATI adjustment amount.
(A) In general.
(B) Special rule for taxable years or specified periods
beginning in 2019 or 2020.
(iii) Applicable partnership.
(h) Election to apply safe-harbor.
(1) In general.
(2) Eligibility for safe-harbor election.
(i) Stand-alone applicable CFC.
(ii) CFC group.
(A) In general.
(B) Currency translation.
(3) Eligible amount.
(i) In general.
(ii) Amounts properly allocable to a non-excepted trade or
business.
(4) Qualified tentative taxable income.
(5) Manner of making a safe-harbor election.
(i) In general.
(ii) Election statement.
(6) Special rule for taxable years or specified periods
beginning in 2019 or 2020.
* * * * *
(j) Rules regarding the computation of ATI of certain United
States shareholders of applicable CFCs.
(1) In general.
(2) Rules for determining CFC excess taxable income.
(i) In general.
(ii) Applicable CFC is a stand-alone applicable CFC.
(iii) Applicable CFC is a CFC group member.
(iv) ATI percentage.
(3) Cases in which an addition to tentative taxable income is
not allowed.
(4) Special rule for taxable years or specified periods
beginning in 2019 or 2020.
(k) Definitions.
(1) Applicable partnership.
(2) Applicable specified taxable year.
(3) ATI adjustment amount.
(4) ATI percentage.
(5) CFC excess taxable income.
(6) CFC group.
(7) CFC group election.
(8) CFC group member.
(9) CFC-level net deemed tangible income return.
(i) In general.
(ii) Amounts properly allocable to a non-excepted trade or
business.
(10) Cumulative section 163(j) pre-group carryforward
limitation.
(11) Current group.
(12) Designated U.S. person.
(13) ECI deemed corporation.
(14) Effectively connected income.
(15) Eligible amount.
(16) Former group.
(17) Loss member.
(18) Payment amount.
(19) Pre-group disallowed business interest expense
carryforward.
(20) Qualified tentative taxable income.
(21) Qualified U.S. person.
(22) Relevant period.
(23) Safe-harbor election.
(24) Specified borrower.
(25) Specified group.
(26) Specified group member.
(27) Specified group parent.
(28) Specified lender.
(29) Specified period.
(i) In general.
(ii) Short specified period.
(30) Specified taxable year.
(31) Stand-alone applicable CFC.
(32) Stock.
(l) Examples.
(m) Applicability dates.
(1) General applicability date.
(2) Exception.
Sec. 1.163(j)-8 Application of the section 163(j) limitation to
foreign persons with effectively connected income.
(a) Overview.
(b) Application to a specified foreign person with ECI.
(1) In general.
(2) Modification of adjusted taxable income.
(3) Modification of business interest expense.
(4) Modification of business interest income.
(5) Modification of floor plan financing interest expense.
(6) Modification of allocation of interest expense and interest
income that is allocable to a trade or business.
(c) Rules for a specified foreign partner.
(1) Characterization of excess taxable income.
(i) In general.
(ii) Specified ATI ratio.
(iii) Distributive share of ECI.
(iv) Distributive share of non-ECI.
(2) Characterization of excess business interest expense.
(i) Allocable ECI excess BIE.
(ii) Allocable non-ECI excess BIE.
[[Page 56894]]
(3) Characterization of deductible business interest expense.
(i) In general.
(ii) Allocation between allocable ECI deductible BIE and
allocable non-ECI deductible BIE.
(A) Allocation to hypothetical deductible amounts.
(1) In general.
(2) Limitation.
(B) Allocation of remaining deductible amounts.
(iii) Hypothetical partnership deductible business interest
expense.
(A) Hypothetical partnership ECI deductible BIE.
(B) Hypothetical partnership non-ECI deductible BIE.
(4) Characterization of excess business interest income.
(i) In general.
(ii) Specified BII ratio.
(iii) Allocable ECI BII.
(5) Rules for determining ECI.
(d) Characterization of disallowed business interest expense by
a relevant foreign corporation with ECI.
(1) Scope.
(2) Characterization of disallowed business interest expense.
(i) FC ECI disallowed BIE.
(ii) FC non-ECI disallowed BIE.
(3) Characterization of deductible business interest expense.
(i) In general.
(ii) Allocation between FC ECI deductible BIE and FC non-ECI
deductible BIE.
(A) Allocation to hypothetical deductible amounts.
(1) In general.
(2) Limitation.
(B) Allocation of remaining deductible amounts.
(iii) Hypothetical FC deductible business interest expense.
(A) Hypothetical FC ECI deductible BIE.
(B) Hypothetical FC non-ECI deductible BIE.
(e) Rules regarding disallowed business interest expense.
(1) Retention of character in a succeeding taxable year.
(2) Deemed allocation of excess business interest expense of a
partnership to a specified foreign partner.
(3) Ordering rule for conversion of excess business interest
expense to business interest expense paid or accrued by a partner.
(4) Allocable ECI excess BIE and allocable non-ECI excess BIE
retains its character when treated as business interest expense paid
or accrued in a succeeding taxable year.
(f) Coordination of the application of section 163(j) with Sec.
1.882-5 and similar provisions and with the branch profits tax.
(1) Coordination of section 163(j) with Sec. 1.882-5 and
similar provisions.
(i) Ordering rule.
(ii) Treatment of excess business interest expense.
(iii) Attribution of certain Sec. 1.882-5 interest expense
among the foreign corporation and its partnership interests.
(A) In general.
(B) Attribution of interest expense on U.S. booked liabilities.
(C) Attribution of excess Sec. 1.882-5 three-step interest
expense.
(1) In general.
(2) Attribution of excess Sec. 1.882-5 three-step interest
expense to the foreign corporation.
(3) Attribution of excess Sec. 1.882-5 three-step interest
expense to partnerships.
(i) In general.
(ii) Direct and indirect partnership interests.
(4) Limitation on attribution of excess Sec. 1.882-5 three-step
interest expense.
(2) Coordination with the branch profits tax.
(g) Definitions.
(1) Sec. 1.882-5 and similar provisions.
(2) Sec. 1.882-5 three-step interest expense.
(3) Allocable ECI BIE.
(4) Allocable ECI BII.
(5) Allocable ECI deductible BIE.
(6) Allocable ECI excess BIE.
(7) Allocable non-ECI BIE.
(8) Allocable non-ECI deductible BIE.
(9) Allocable non-ECI excess BIE.
(10) Distributive share of ECI.
(11) Distributive share of non-ECI.
(12) Effectively connected income.
(13) Excess Sec. 1.882-5 three-step interest expense.
(14) FC ECI BIE.
(15) FC ECI deductible BIE.
(16) FC ECI disallowed BIE.
(17) FC non-ECI BIE.
(18) FC non-ECI deductible BIE.
(19) FC non-ECI disallowed BIE.
(20) Hypothetical partnership ECI deductible BIE.
(21) Hypothetical partnership non-ECI deductible BIE.
(22) Hypothetical FC ECI deductible BIE.
(23) Hypothetical FC non-ECI deductible BIE.
(24) Specified ATI ratio.
(25) Specified BII ratio.
(26) Specified foreign partner.
(27) Specified foreign person.
(28) Successor.
(h) Examples.
(i) [Reserved]
(j) Applicability date.
Sec. 1.163(j)-10 Allocation of interest expense, interest income,
and other items of expense and gross income to an excepted trade or
business.
* * * * *
(c) * * *
(5) * * *
(ii) * * *
(D) Limitations on application of look-through rules.
(1) Inapplicability of look-through rule to partnerships or non-
consolidated C corporations to which the small business exemption
applies.
(2) Limitation on application of look-through rule to C
corporations.
* * * * *
(f) Applicability dates.
(1) In general.
(2) Paragraph (c)(5)(ii)(D)(2).
0
Par. 5.As added in a final rule published elsewhere in this issue of
the Federal Register, effective November 13, 2020, Sec. 1.163(j)-1 is
amended by:
0
1. Revising paragraph (b)(1)(iv)(B).
0
2. Adding paragraphs (b)(1)(iv)(E), (b)(22)(iii)(F), and (b)(35)
0
3. In paragraph (c)(1), removing ``paragraphs (c)(2) and (3)'' from the
first sentence and adding ``paragraphs (c)(2), (3), and (4)'' in its
place.
0
4. Adding paragraph (c)(4).
The revisions and additions read as follows:
Sec. 1.163(j)-1 Definitions.
* * * * *
(b) * * *
(1) * * *
(iv) * * *
(B) Deductions by members of a consolidated group--(1) In general.
If paragraph (b)(1)(ii)(C), (D), or (E) of this section applies to
adjust the tentative taxable income of a taxpayer, and if the taxpayer
does not use the computation method in paragraph (b)(1)(iv)(E) of this
section, the amount of the adjustment under paragraph (b)(1)(ii)(C) of
this section equals the greater of the allowed or allowable
depreciation, amortization, or depletion of the property, as provided
under section 1016(a)(2), for any member of the consolidated group for
the taxable years beginning after December 31, 2017, and before January
1, 2022, with respect to such property.
(2) Application of the alternative computation method. If paragraph
(b)(1)(ii)(C), (D), or (E) of this section applies to adjust the
tentative taxable income of a taxpayer, and if the taxpayer uses the
computation method in paragraph (b)(1)(iv)(E) of this section, the
amount of the adjustment under paragraph (b)(1)(ii)(C) of this section
equals the lesser of:
(i) Any gain recognized on the sale or other disposition of such
property by the taxpayer (or, if the taxpayer is a member of a
consolidated group, the consolidated group); and
(ii) The greater of the allowed or allowable depreciation,
amortization, or depletion of the property, as provided under section
1016(a)(2), for the taxpayer (or, if the taxpayer is a member of a
consolidated group, the consolidated group) for the taxable years
beginning after December 31, 2017, and before January 1, 2022, with
respect to such property.
* * * * *
(E) Alternative computation method. If paragraph (b)(1)(ii)(C),
(D), or (E) of this section applies to adjust the tentative taxable
income of a taxpayer, the taxpayer may compute the amount of the
adjustments required by such paragraph using the formulas in paragraph
(b)(1)(iv)(E)(1), (2), and (3) of this section, respectively, provided
that the taxpayer applies such formulas to all
[[Page 56895]]
dispositions for which an adjustment is required under paragraph
(b)(1)(ii)(C), (D), or (E) of this section.
(1) Alternative computation method for property dispositions. With
respect to the sale or other disposition of property, the lesser of:
(i) Any gain recognized on the sale or other disposition of such
property by the taxpayer (or, if the taxpayer is a member of a
consolidated group, the consolidated group); and
(ii) The greater of the allowed or allowable depreciation,
amortization, or depletion of the property, as provided under section
1016(a)(2), for the taxpayer (or, if the taxpayer is a member of a
consolidated group, the consolidated group) for the taxable years
beginning after December 31, 2017, and before January 1, 2022, with
respect to such property.
(2) Alternative computation method for dispositions of member
stock. With respect to the sale or other disposition of stock of a
member of a consolidated group by another member, the lesser of:
(i) Any gain recognized on the sale or other disposition of such
stock; and
(ii) The investment adjustments under Sec. 1.1502-32 with respect
to such stock that are attributable to deductions described in
paragraph (b)(1)(ii)(C) of this section.
(3) Alternative computation method for dispositions of partnership
interests. With respect to the sale or other disposition of an interest
in a partnership, the lesser of (i) any gain recognized on the sale or
other disposition of such interest, and (ii) the taxpayer's (or, if the
taxpayer is a consolidated group, the consolidated group's)
distributive share of deductions described in paragraph (b)(1)(ii)(C)
of this section with respect to property held by the partnership at the
time of such sale or other disposition to the extent such deductions
were allowable under section 704(d).
* * * * *
(22) * * *
(iii) * * *
(F) Section 163(j) interest dividends--(1) In general. Except as
otherwise provided in this paragraph (b)(22)(iii)(F), a section 163(j)
interest dividend is treated as interest income.
(2) Limitation on amount treated as interest income. A shareholder
may not treat any part of a section 163(j) interest dividend as
interest income to the extent the amount of the section 163(j) interest
dividend exceeds the excess of the amount of the entire dividend that
includes the section 163(j) interest dividend over the sum of the
conduit amounts other than interest-related dividends under section
871(k)(1)(C) and section 163(j) interest dividends that affect the
shareholder's treatment of that dividend.
(3) Conduit amounts. For purposes of paragraph (b)(22)(iii)(F)(2)
of this section, the term conduit amounts means, with respect to any
category of income (including tax-exempt interest) earned by a RIC for
a taxable year, the amounts identified by the RIC (generally in a
designation or written report) in connection with dividends paid by the
RIC for that taxable year that are subject to a limit determined by
reference to that category of income. For example, a RIC's conduit
amount with respect to its net capital gain is the amount of capital
gain dividends that the RIC pays under section 852(b)(3)(C).
(4) Holding period. Except as provided in paragraph
(b)(22)(iii)(F)(5) of this section, no dividend is treated as interest
income under paragraph (b)(22)(iii)(F)(1) of this section if the
dividend is received with respect to a share of RIC stock--
(i) That is held by the shareholder for 180 days or less (taking
into account the principles of section 246(c)(3) and (4)) during the
361-day period beginning on the date which is 180 days before the date
on which the share becomes ex-dividend with respect to such dividend;
or
(ii) To the extent that the shareholder is under an obligation
(whether pursuant to a short sale or otherwise) to make related
payments with respect to positions in substantially similar or related
property.
(5) Exception to holding period requirement for money market funds
and certain regularly declared dividends. Paragraph
(b)(22)(iii)(F)(4)(i) of this section does not apply to dividends
distributed by any RIC regulated as a money market fund under 17 CFR
270.2a-7 (Rule 2a-7 under the 1940 Act) or to regular dividends paid by
a RIC that declares section 163(j) interest dividends on a daily basis
in an amount equal to at least 90 percent of its excess section 163(j)
interest income, as defined in paragraph (b)(35)(iv)(E) of this
section, and distributes such dividends on a monthly or more frequent
basis.
* * * * *
(35) Section 163(j) interest dividend. The term section 163(j)
interest dividend means a dividend paid by a RIC for a taxable year for
which section 852(b) applies to the RIC, to the extent described in
paragraph (b)(35)(i) or (ii) of this section, as applicable.
(i) In general. Except as provided in paragraph (b)(35)(ii) of this
section, a section 163(j) interest dividend is any dividend, or part of
a dividend, that is reported by the RIC as a section 163(j) interest
dividend in written statements furnished to its shareholders.
(ii) Reduction in the case of excess reported amounts. If the
aggregate reported amount with respect to the RIC for the taxable year
exceeds the excess section 163(j) interest income of the RIC for such
taxable year, the section 163(j) interest dividend is--
(A) The reported section 163(j) interest dividend amount; reduced
by
(B) The excess reported amount that is allocable to that reported
section 163(j) interest dividend amount.
(iii) Allocation of excess reported amount--(A) In general. Except
as provided in paragraph (b)(35)(iii)(B) of this section, the excess
reported amount, if any, that is allocable to the reported section
163(j) interest dividend amount is that portion of the excess reported
amount that bears the same ratio to the excess reported amount as the
reported section 163(j) interest dividend amount bears to the aggregate
reported amount.
(B) Special rule for noncalendar year RICs. In the case of any
taxable year that does not begin and end in the same calendar year, if
the post-December reported amount equals or exceeds the excess reported
amount for that taxable year, paragraph (b)(35)(iii)(A) of this section
is applied by substituting ``post-December reported amount'' for
``aggregate reported amount,'' and no excess reported amount is
allocated to any dividend paid on or before December 31 of such taxable
year.
(iv) Definitions. The following definitions apply for purposes of
this paragraph (b)(35):
(A) Reported section 163(j) interest dividend amount. The term
reported section 163(j) interest dividend amount means the amount of a
dividend distribution reported to the RIC's shareholders under
paragraph (b)(35)(i) of this section as a section 163(j) interest
dividend.
(B) Excess reported amount. The term excess reported amount means
the excess of the aggregate reported amount over the RIC's excess
section 163(j) interest income for the taxable year.
(C) Aggregate reported amount. The term aggregate reported amount
means the aggregate amount of dividends reported by the RIC under
paragraph (b)(35)(i) of this section as section 163(j) interest
dividends for the taxable year (including section 163(j) interest
dividends paid after the close of the taxable year described in section
855).
(D) Post-December reported amount. The term post-December reported
[[Page 56896]]
amount means the aggregate reported amount determined by taking into
account only dividends paid after December 31 of the taxable year.
(E) Excess section 163(j) interest income. The term excess section
163(j) interest income means, with respect to a taxable year of a RIC,
the excess of the RIC's business interest income for the taxable year
over the sum of the RIC's business interest expense for the taxable
year and the RIC's other deductions for the taxable year that are
properly allocable to the RIC's business interest income.
(v) Example--(A) Facts. X is a domestic C corporation that has
elected to be a RIC. For its taxable year ending December 31, 2021,
X has $100x of business interest income (all of which is qualified
interest income for purposes of section 871(k)(1)(E)) and $10x of
dividend income (all of which is qualified dividend income within
the meaning of section 1(h)(11) and would be eligible for the
dividends received deduction under section 243, determined as
described in section 854(b)(3)). X has $10x of business interest
expense and $20x of other deductions. X has no other items for the
taxable year. On December 31, 2021, X pays a dividend of $80x to its
shareholders, and reports, in written statements to its
shareholders, $71.82x as a section 163(j) interest dividend; $10x as
dividends that may be treated as qualified dividend income or as
dividends eligible for the dividends received deduction; and $72.73x
as interest-related dividends under section 871(k)(1)(C).
Shareholder A, a domestic C corporation, meets the holding period
requirements in paragraph (b)(22)(iii)(F)(4) of this section with
respect to the stock of X, and receives a dividend of $8x from X on
December 31, 2021.
(B) Analysis. X determines that $18.18x of other deductions are
properly allocable to X's business interest income. X's excess
section 163(j) interest income under paragraph (b)(35)(iv)(E) of
this section is $71.82x ($100x business interest income-($10x
business interest expense + $18.18x other deductions allocated) =
$71.82x). Thus, X may report up to $71.82x of its dividends paid on
December 31, 2021, as section 163(j) interest dividends to its
shareholders. X may also report up to $10x of its dividends paid on
December 31, 2021, as dividends that may be treated as qualified
dividend income or as dividends that are eligible for the dividends
received deduction. X determines that $9.09x of interest expense and
$18.18x of other deductions are properly allocable to X's qualified
interest income. Therefore, X may report up to $72.73x of its
dividends paid on December 31, 2021, as interest-related dividends
under section 871(k)(1)(C) ($100x qualified interest income-$27.27x
deductions allocated = $72.73x). A treats $1x of its $8x dividend as
a dividend eligible for the dividends received deduction and no part
of the dividend as an interest-related dividend under section
871(k)(1)(C). Therefore, under paragraph (b)(22)(iii)(F)(2) of this
section, A may treat $7x of the section 163(j) interest dividend as
interest income for purposes of section 163(j) ($8x dividend-$1x
conduit amount = $7x limitation).
* * * * *
(c) * * *
(4) Alternative computation for certain adjustments to tentative
taxable income, and section 163(j) interest dividends--(i) Alternative
computation for certain adjustments to tentative taxable income.
Paragraphs (b)(1)(iv)(B) and (E) of this section apply to taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE Federal Register]. Taxpayers and their related
parties, within the meaning of sections 267(b) and 707(b)(1), may
choose to apply the rules in paragraphs (b)(1)(iv)(B) and (E) of this
section to a taxable year beginning after December 31, 2017, and before
[DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE
Federal Register], so long as the taxpayers and their related parties
consistently apply the rules of the section 163(j) regulations, and, if
applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1,
1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-
11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-
21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent
they effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and
1.383-1), and 1.1504-4, to that taxable year and each subsequent
taxable year.
(ii) Section 163(j) interest dividends. Paragraphs (b)(22)(iii)(F)
and (b)(35) of this section apply to taxable years beginning on or
after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE
Federal Register]. Taxpayers and their related parties, within the
meaning of sections 267(b) and 707(b)(1), may choose to apply the rules
in paragraphs (b)(22)(iii)(F) and (b)(35) of this section for a taxable
year beginning after December 31, 2017, and before [DATE 60 DAYS AFTER
DATE OF PUBLICATION OF THE FINAL RULE IN THE Federal Register], so long
as the taxpayers and their related parties consistently apply the rules
of the section 163(j) regulations.
0
Par. 6. As added in a final rule published elsewhere in this issue of
the Federal Register, effective November 13, 2020, Sec. 1.163(j)-2 is
amended by:
0
1. Adding paragraphs (b)(3)(iii) and (iv) and (d)(3).
0
2. Redesignating paragraph (k) as paragraph (k)(1).
0
3. Adding a new subject heading for paragraph (k).
0
4. Revising the subject heading of redesignated paragraph (k)(1).
0
5. Adding paragraph (k)(2).
The additions and revision read as follows:
Sec. 1.163(j)-2 Deduction for business interest expense limited.
* * * * *
(b) * * *
(3) * * *
(iii) Transactions to which section 381 applies. For purposes of
the election described in paragraph (b)(3)(i) of this section, and
subject to the limitation in paragraph (b)(3)(ii) of this section, the
2019 ATI of the acquiring corporation in a transaction to which section
381 applies equals the amount of the acquiring corporation's ATI for
its last taxable year beginning in 2019.
(iv) Consolidated groups. For purposes of the election described in
paragraph (b)(3)(i) of this section, and subject to the limitation in
paragraph (b)(3)(ii) of this section, the 2019 ATI of a consolidated
group equals the amount of the consolidated group's ATI for its last
taxable year beginning in 2019.
* * * * *
(d) * * *
(3) Determining a syndicate's loss amount. For purposes of section
163(j), losses allocated under section 1256(e)(3)(B) and Sec. 1.448-
1T(b)(3) are determined without regard to section 163(j). See also
Sec. 1.1256(e)-2(b).
* * * * *
(k) Applicability dates.
(1) In general. * * *
(2) Paragraphs (b)(3)(iii), (b)(3)(iv), and (d)(3). Paragraphs
(b)(3)(iii) and (iv) and (d)(3) of this section apply to taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER]. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply the rules of paragraphs (b)(3)(iii) and (iv) of
this section to a taxable year beginning after December 31, 2017, and
before [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE
FEDERAL REGISTER], provided that they consistently apply the rules of
paragraphs (b)(3)(iii) and (iv) of this section and the rules in the
section 163(j) regulations for that taxable year and for each
subsequent taxable year. Taxpayers and their related parties, within
the meaning of sections 267(b) and 707(b), may choose to apply the
rules of paragraph (d)(3) of this section to a taxable year beginning
after December 31, 2017, and before [DATE 60 DAYS AFTER DATE OF
PUBLICATION OF THE FINAL RULE
[[Page 56897]]
IN THE FEDERAL REGISTER], provided that they consistently apply the
rules of paragraph (d)(3) of this section for that taxable year and for
each subsequent taxable year.
0
Par. 7.As added in a final rule published elsewhere in this issue of
the Federal Register, effective November 13, 2020, Sec. 1.163(j)-6 is
amended by:
0
1. Adding paragraphs (c)(1) and (2), (d)(3) through (5), (e)(5) and
(6), (f)(1)(iii), (g)(4), (h)(4) and (5), (j), (l)(4)(iv), (n), and
(o)(24) through (29).
0
2. Redesignating paragraph (p) as paragraph (p)(1).
0
3. Adding a new subject heading for paragraph (p).
0
4. Revising the subject heading of newly redesignated paragraph (p)(1).
0
5. Adding paragraph (p)(2).
The additions and revision read as follows:
Sec. 1.163(j)-6 Application of the business interest deduction
limitation to partnerships and subchapter S corporations.
* * * * *
(c) * * *
(1) Modification of business interest income for partnerships. The
business interest income of a partnership generally is determined in
accordance with Sec. 1.163(j)-1(b)(3). To the extent that interest
income of a partnership that is properly allocable to trades or
businesses that are per se non-passive activities and is allocated to
partners that do not materially participate (within the meaning of
section 469), as described in section 163(d)(5)(A)(ii), such interest
income shall not be considered business interest income for purposes of
determining the section 163(j) limitation of a partnership pursuant to
Sec. 1.163(j)-2(b). A per se non-passive activity is an activity that
is not treated as a passive activity for purposes of section 469
regardless of whether the owners of the activity materially participate
in the activity.
(2) Modification of business interest expense for partnerships. The
business interest expense of a partnership generally is determined in
accordance with Sec. 1.163(j)-1(b)(2). To the extent that interest
expense of a partnership that is properly allocable to trades or
businesses that are per se non-passive activities is allocated to
partners that do not materially participate within the meaning of
section 469, as described in section 163(d)(5)(A)(ii), such interest
expense shall not be considered business interest expense for purposes
of determining the section 163(j) limitation of a partnership pursuant
to Sec. 1.163(j)-2(b).
* * * * *
(d) * * *
(3) Section 743(b) adjustments and publicly traded partnerships.
Solely for purposes of Sec. 1.163(j)-6, a publicly traded partnership,
as defined in Sec. 1.7704-1, shall treat the amount of any section
743(b) adjustment of a purchaser of a partnership unit that relates to
a remedial item that the purchaser inherits from the seller as an
offset to the related section 704(c) remedial item. For this purpose,
Sec. 1.163(j)-6(e)(2)(ii) applies. See Example 25 in paragraph (o)(25)
of this section.
(4) Modification of adjusted taxable income for partnerships. The
adjusted taxable income of a partnership generally is determined in
accordance with Sec. 1.163(j)-1(b)(1). To the extent that the items
comprising the adjusted taxable income of a partnership are properly
allocable to trades or businesses that are per se non-passive
activities and are allocated to partners that do not materially
participate (within the meaning of section 469), as described in
section 163(d)(5)(A)(ii), such partnership items shall not be
considered adjusted taxable income for purposes of determining the
section 163(j) limitation of a partnership pursuant to Sec. 1.163(j)-
2(b).
(5) Election to use 2019 adjusted taxable income for taxable years
beginning in 2020. In the case of any taxable year beginning in 2020, a
partnership may elect to apply this section by substituting its
adjusted taxable income for the last taxable year beginning in 2019 for
the adjusted taxable income for such taxable year. See Sec. 1.163(j)-
2(b)(4) for the time and manner of making or revoking this election. An
electing partnership determines each partner's allocable ATI (as
defined in paragraph (f)(2)(ii) of this section) pursuant to paragraph
(j)(9) of this section in the same manner as an upper-tier partnership.
See Example 34 in paragraph (o)(34) of this section.
* * * * *
(e) * * *
(5) Partner basis items, remedial items, and publicly traded
partnerships. Solely for purposes of Sec. 1.163(j)-6, a publicly
traded partnership, as defined in Sec. 1.7704-1, shall either allocate
gain that would otherwise be allocated under section 704(c) based on a
partner's section 704(b) sharing ratios, or, for purposes of allocating
cost recovery deductions under section 704(c), determine a partner's
remedial items, as defined in Sec. 1.163(j)-6(b)(3), based on an
allocation of the partnership's asset basis (inside basis) items among
its partners in proportion to their share of corresponding section
704(b) items (rather than applying the traditional method, described in
Sec. 1.704-3(b)). See Example 24 in paragraph (o)(24) of this section.
(6) Partnership deductions capitalized by a partner. The ATI of a
partner is increased by the portion of such partner's allocable share
of qualified expenditures (as defined in section 59(e)(2)) to which an
election under section 59(e) applies.
* * * * *
(f) * * *
(1) * * *
(iii) Exception applicable to publicly traded partnerships.
Publicly traded partnerships, as defined in Sec. 1.7704-1, do not
apply the rules in paragraph (f)(2) of this section to determine a
partner's share of section 163(j) excess items. Rather, publicly traded
partnerships determine a partner's share of section 163(j) excess items
by applying the same percentage used to determine the partner's share
of the corresponding section 704(b) items that comprise ATI.
* * * * *
(g) * * *
(4) Special rule for taxable years beginning in 2019 and 2020. In
the case of any excess business interest expense of a partnership for
any taxable year beginning in 2019 that is allocated to a partner under
paragraph (f)(2) of this section, 50 percent of such excess business
interest expense (Sec. 1.163(j)-6(g)(4) business interest expense) is
treated as business interest expense that, notwithstanding paragraph
(g)(2) of this section, is paid or accrued by the partner in the
partner's first taxable year beginning in 2020. Additionally, Sec.
1.163(j)-6(g)(4) business interest expense is not subject to the
section 163(j) limitation at the level of the partner. For purposes of
paragraph (h)(1) of this section, any Sec. 1.163(j)-6(g)(4) business
interest expense is, similar to deductible business interest expense,
taken into account before any excess business interest expense. This
paragraph applies after paragraph (n) of this section. If a partner
disposes of a partnership interest in the partnership's 2019 or 2020
taxable year, Sec. 1.163(j)-6(g)(4) business interest expense is
deductible by the partner and thus does not result in a basis increase
under paragraph (h)(3) of this section. See Example 35 and Example 36
in paragraphs (o)(35) and (o)(36), respectively, of this section. A
taxpayer may elect to not have this provision apply. The rules and
procedures regarding the time and manner of making, or revoking, such
an election are provided in Revenue Procedure 2020-22, 2020-18 I.R.B.
745, and may
[[Page 56898]]
be further modified through other guidance (see Sec. Sec. 601.601(d)
and 601.602 of this chapter).
* * * * *
(h) * * *
(4) Partner basis adjustments upon liquidating distribution. For
purposes of paragraph (h)(3) of this section, a disposition includes a
distribution of money or other property by the partnership to a partner
in complete liquidation of the partner's interest in the partnership.
However, a current distribution of money or other property by the
partnership to a continuing partner is not a disposition for purposes
of paragraph (h)(3) of this section.
(5) Partnership basis adjustments upon partner dispositions. If a
partner (transferor) disposes of its partnership interest, the
partnership shall increase the adjusted basis of partnership property
by an amount equal to the amount of the increase required under
paragraph (h)(3) (or, if the transferor is a partnership, (j)(5)(ii))
of this section (if any) to the adjusted basis of the partnership
interest being disposed of by the transferor. Such increase in the
adjusted basis of partnership property (Sec. 1.163(j)-6(h)(5) basis
adjustment) shall be allocated among capital gain property of the
partnership in the same manner as a positive section 734(b) adjustment.
However, the increase in the adjusted basis of any partnership property
resulting from a Sec. 1.163(j)-6(h)(5) basis adjustment is not
depreciable or amortizable under any section of the Code, regardless of
whether the partnership property allocated such Sec. 1.163(j)-6(h)(5)
basis adjustment is otherwise generally depreciable or amortizable. In
general, a partnership allocates its Sec. 1.163(j)-6(h)(5) basis
adjustment immediately before the disposition (simultaneous with the
transferor's basis increase required under paragraph (h)(3) or
(j)(5)(ii) of this section). However, if the disposition was the result
of a distribution by the partnership of money or other property to the
transferor in complete liquidation of the transferor's interest in the
partnership, the partnership allocates its Sec. 1.163(j)-6(h)(5) basis
adjustment among its properties only after it has allocated its section
734(b) adjustment (if any) among its properties. See Example 31 in
paragraph (o)(31) of this section.
* * * * *
(j) Tiered partnerships--(1) Purpose. The purpose of this section
is to provide guidance regarding the treatment of business interest
expense of a partnership (lower-tier partnership) that is allocated to
a partner that is a partnership (upper-tier partnership). Specifically,
this section clarifies that disparities are not created between an
upper-tier partner's basis in its upper-tier partnership interest and
such partner's share of the adjusted basis of upper-tier partnership's
property following the allocation of excess business interest expense
from lower-tier partnership to upper-tier partnership. Further, these
rules disallow any deduction for business interest expense that was
formerly excess business interest expense to any person that is not the
specified partner of such business interest expense. See Example 27
through Example 30 in paragraphs (o)(27) through (30), respectively.
(2) Section 704(b) capital account adjustments. If lower-tier
partnership pays or accrues business interest expense and allocates
such business interest expense to upper-tier partnership, then both
upper-tier partnership and any direct or indirect partners of upper-
tier partnership shall, solely for purposes of section 704(b) and the
regulations thereunder, treat such business interest expense as a
section 705(a)(2)(B) expenditure. Any section 704(b) capital account
reduction resulting from such treatment occurs regardless of whether
such business interest expense is characterized under this section as
excess business interest expense or deductible business interest
expense by lower-tier partnership. If upper-tier partnership
subsequently treats any excess business interest expense allocated from
lower-tier partnership as business interest expense paid or accrued
pursuant to paragraph (g) of this section, the section 704(b) capital
accounts of any direct or indirect partners of upper-tier partnership
are not further reduced.
(3) Basis adjustments of upper-tier partnership. If lower-tier
partnership allocates excess business interest expense to upper-tier
partnership, then upper-tier partnership reduces its basis in lower-
tier partnership pursuant to paragraph (h)(2) of this section. Upper-
tier partnership partners do not, however, reduce the bases of their
upper-tier partnership interests pursuant to paragraph (h)(2) of this
section until upper-tier partnership treats such excess business
interest expense as business interest expense paid or accrued pursuant
to paragraph (g) of this section.
(4) Treatment of excess business interest expense allocated by
lower-tier partnership to upper-tier partnership. Except as provided in
paragraph (j)(7) of this section, if lower-tier partnership allocates
excess business interest expense to upper-tier partnership and such
excess business interest expense is not suspended under section 704(d),
then upper-tier partnership shall treat such excess business interest
expense (UTP EBIE) as a nondepreciable capital asset, with a fair
market value of zero and basis equal to the amount by which upper-tier
partnership reduced its basis in lower-tier partnership pursuant to
paragraph (h)(2) of this section due to the allocation of such excess
business interest expense. The fair market value of UTP EBIE, described
in the preceding sentence, is not adjusted by any revaluations
occurring under Sec. 1.704-1(b)(2)(iv)(f). In addition to generally
treating UTP EBIE as having a basis component in excess of fair market
value and, thus, built-in loss property, upper-tier partnership shall
also treat UTP EBIE as having a carryforward component associated with
it. The carryforward component of UTP EBIE shall equal the amount of
excess business interest expense allocated from lower-tier partnership
to upper-tier partnership under paragraph (f)(2) of this section that
is treated as such under paragraph (h)(2) of this section by upper-tier
partnership. If an allocation of excess business interest expense from
lower-tier partnership is treated as UTP EBIE of upper-tier
partnership, upper-tier partnership shall treat such allocation of
excess business interest expense from lower-tier partnership as UTP
EBIE until the occurrence of an event described in paragraph (j)(5) of
this section.
(5) UTP EBIE conversion events--(i) Allocation to upper-tier
partnership by lower-tier partnership of excess taxable income (or
excess business interest income). To the extent upper-tier partnership
is allocated excess taxable income (or excess business interest income)
from lower-tier partnership, or paragraph (m)(3) of this section
applies, upper-tier partnership shall--
(A) First, apply the rules in paragraph (g) of this section to its
UTP EBIE, using any reasonable method (including, for example, FIFO and
LIFO) to determine which UTP EBIE is treated as business interest
expense paid or accrued pursuant paragraph (g) of this section. If
paragraph (m)(3) of this section applies, upper-tier partnership shall
treat all of its UTP EBIE from lower-tier partnership as business
interest expense paid or accrued.
(B) Second, with respect to any UTP EBIE treated as business
interest expense paid or accrued in paragraph (j)(5)(i)(A) of this
section, allocate any business interest expense that was formerly such
UTP EBIE to its specified partner. For purposes of this section, the
[[Page 56899]]
term specified partner refers to the partner of upper-tier partnership
that, due to the initial allocation of excess business interest expense
from lower-tier partnership to upper-tier partnership, was required to
reduce its section 704(b) capital account pursuant to paragraph (j)(2)
of this section. Similar principles apply if the specified partner of
such business interest expense is itself a partnership. See paragraph
(j)(6) of this section for rules that apply if a specified partner
disposes of its partnership interest.
(C) Third, in the manner provided in paragraph (j)(7)(ii) (or
(iii), as the case may be) of this section, take into account any
negative basis adjustments under section 734(b) previously made to the
UTP EBIE treated as business interest expense paid or accrued in
paragraph (j)(5)(i)(A) of this section. Additionally, persons treated
as specified partners with respect to the UTP EBIE treated as business
interest expense paid or accrued in paragraph (j)(5)(i)(A) shall take
any negative basis adjustments under section 743(b) into account in the
manner provided in paragraph (j)(7)(ii) (or (iii), as the case may be)
of this section.
(ii) Upper-tier partnership disposition of lower-tier partnership
interest. If upper-tier partnership disposes of a lower-tier
partnership interest (transferred interest), upper-tier partnership
shall--
(A) First, apply the rules in paragraph (h)(3) of this section
(except as provided in paragraphs (j)(5)(ii)(B) and (C) of this
section), using any reasonable method (including, for example, FIFO and
LIFO) to determine which UTP EBIE is reduced pursuant paragraph (h)(3)
of this section.
(B) Second, increase the adjusted basis of the transferred interest
immediately before the disposition by the total amount of the UTP EBIE
that was reduced in paragraph (j)(5)(ii)(A) of this section (the amount
of UTP EBIE proportionate to the transferred interest).
(C) Third, in the manner provided in paragraph (j)(7)(iv) of this
section, take into account any negative basis adjustments under
sections 734(b) and 743(b) previously made to the UTP EBIE that was
reduced in (A) earlier.
(6) Disposition of a specified partner's partnership interest--(i)
General rule. If a specified partner (transferor) disposes of an upper-
tier partnership interest (or an interest in a partnership that itself
is a specified partner), the portion of any UTP EBIE to which the
transferor's status as specified partner relates is not reduced
pursuant to paragraph (j)(5)(ii) of this section. Rather, such UTP EBIE
attributable to the interest disposed of is retained by upper-tier
partnership and the transferee is treated as the specified partner for
purposes of this section with respect to such UTP EBIE. Thus, upper-
tier partnership must allocate any business interest expense that was
formerly such UTP EBIE to the transferee. However, see paragraph (j)(8)
of this section for rules regarding the deductibility of such
transferee's business interest expense that was formerly UTP EBIE.
(ii) Special rules--(A) Distribution in liquidation of a specified
partner's partnership interest. If a specified partner receives a
distribution of property in complete liquidation of an upper-tier
partnership interest, the portion of UTP EBIE of upper-tier partnership
attributable to the liquidated interest shall not have a specified
partner. If a specified partner (transferee) receives a distribution of
an interest in upper-tier partnership in complete liquidation of a
partnership interest, the transferee is the specified partner with
respect to UTP EBIE of upper-tier partnership only to the same extent
it was prior to the distribution. Similar principles apply where an
interest in a partnership that is a specified partner is distributed in
complete liquidation of a transferee's partnership interest. See
paragraph (j)(8) of this section for rules regarding the treatment of
UTP EBIE that does not have a specified partner.
(B) Contribution of a specified partner's partnership interest. If
a specified partner (transferor) contributes an upper-tier partnership
interest to a partnership (transferee), the transferee is treated as
the specified partner with respect to the portion of the UTP EBIE
attributable to the contributed interest. Following the transaction,
the transferor continues to be the specified partner with respect to
the UTP EBIE attributable to the contributed interest. Similar
principles apply where an interest in a partnership that is a specified
partner is contributed to a partnership.
(7) Effect of basis adjustments allocated to UTP EBIE--(i) In
general. Negative basis adjustments under sections 734(b) and 743(b)
allocated to UTP EBIE do not affect the carryforward component
(described in paragraph (j)(4) of this section) of such UTP EBIE.
Rather, negative basis adjustments under sections 734(b) and 743(b)
affect only the basis component of such UTP EBIE. For purposes of
Sec. Sec. 1.743-1(d), 1.755-1(b), and 1.755-1(c), the amount of tax
loss that would be allocated to a transferee from a hypothetical
disposition by upper-tier partnership of its UTP EBIE equals the
adjusted basis of the UTP EBIE to which the transferee's status as
specified partner relates. Additionally, solely for purposes of Sec.
1.755-1(b), upper-tier partnership shall treat UTP EBIE as an ordinary
asset of upper-tier partnership.
(ii) UTP EBIE treated as deductible business interest expense. If
UTP EBIE that was allocated a negative section 734(b) adjustment is
subsequently treated as deductible business interest expense, then such
deductible business interest expense does not result in a deduction to
the upper-tier partnership or the specified partner of such deductible
business interest expense. If UTP EBIE that was allocated a negative
section 743(b) adjustment is subsequently treated as deductible
business interest expense, the specified partner of such deductible
business interest expense recovers any negative section 743(b)
adjustment attributable to such deductible business interest expense
(effectively eliminating any deduction for such deductible business
interest expense).
(iii) UTP EBIE treated as excess business interest expense. If UTP
EBIE that was allocated a negative section 734(b) or 743(b) adjustment
is subsequently treated as excess business interest expense, the
specified partner's basis decrease in its upper-tier partnership
interest required under paragraph (h)(2) of this section is reduced by
the amount of the negative section 734(b) or 743(b) adjustment
previously made to such excess business interest expense. If such
excess business interest expense is subsequently treated as business
interest expense paid or accrued by the specified partner, no deduction
shall be allowed for any of such business interest expense. If the
specified partner of such excess business interest expense is a
partnership, such excess business interest expense is considered UTP
EBIE that was previously allocated a negative section 734(b) adjustment
for purposes of this section.
(iv) UTP EBIE reduced due to a disposition. If UTP EBIE that was
allocated a negative section 734(b) or 743(b) adjustment is reduced
pursuant to paragraph (j)(5)(ii)(A) of this section, the amount of
upper-tier partnership's basis increase under paragraph (j)(5)(ii)(B)
of this section to the disposed of lower-tier partnership interest is
reduced by the amount of the negative section 734(b) or 743(b)
adjustment previously made to such UTP EBIE.
(8) Anti-loss trafficking--(i) Transferee specified partner. No
deduction shall be allowed to any
[[Page 56900]]
transferee specified partner for any business interest expense derived
from a transferor's share of UTP EBIE. For purposes of this section,
the term transferee specified partner refers to any specified partner
that did not reduce its section 704(b) capital account due to the
initial allocation of excess business interest expense from lower-tier
partnership to upper-tier partnership pursuant to paragraph (j)(2) of
this section. However, the transferee described in paragraph
(j)(6)(ii)(B) of this section is not a transferee specified partner for
purposes of this section. If pursuant to paragraph (j)(5)(i)(B) of this
section a transferee specified partner is allocated business interest
expense derived from a transferor's share of UTP EBIE (business
interest expense to which the partner's status as transferee specified
partner relates), the transferee specified partner is deemed to recover
a negative section 743(b) adjustment with respect to, and in the amount
of, such business interest expense and takes such negative section
743(b) adjustment into account in the manner provided in paragraph
(j)(7)(ii) (or (iii), as the case may be) of this section, regardless
of whether a section 754 election was in effect or a substantial built-
in loss existed at the time of the transfer by which the transferee
specified partner acquired the transferred interest. However, to the
extent a negative section 734(b) or 743(b) adjustment was previously
made to such business interest expense, the transferee specified
partner does not recover an additional negative section 743(b)
adjustment pursuant to this paragraph.
(ii) UTP EBIE without a specified partner. If UTP EBIE does not
have a specified partner (as the result of a transaction described in
paragraph (j)(6)(ii)(A) of this section), upper-tier partnership shall
not allocate any business interest expense that was formerly such UTP
EBIE to its partners. Rather, for purposes of applying paragraph (f)(2)
of this section, upper-tier partnership shall treat such business
interest expense as the allocable business interest expense (as defined
in paragraph (f)(2)(ii) of this section) of a Sec. 1.163(j)-
6(j)(8)(ii) account. Additionally, if UTP EBIE that does not have a
specified partner (as the result of a transaction described in
paragraph (j)(6)(ii)(A) of this section) is treated as paid or accrued
pursuant to paragraph (g) of this section, upper-tier partnership shall
make a Sec. 1.163(j)-6(h)(5) basis adjustment to its property in the
amount of the adjusted basis (if any) of such UTP EBIE at the time such
UTP EBIE is treated as business interest expense paid or accrued
pursuant to paragraph (g) of this section.
(iii) Disallowance of addback. No basis increase under paragraph
(j)(5)(ii) of this section shall be allowed to upper-tier partnership
for any disallowed UTP EBIE. For purposes of this section, the term
disallowed UTP EBIE refers to any UTP EBIE that has a specified partner
that is a transferee specified partner (as defined in paragraph
(j)(8)(i) of this section) and any UTP EBIE that does not have a
specified partner (as the result of a transaction described in
paragraph (j)(6)(ii)(A) of this section). For purposes of applying
paragraph (j)(5)(ii) of this section, upper-tier partnership shall
treat any disallowed UTP EBIE in the same manner as UTP EBIE that has
previously been allocated a negative section 734(b) adjustment and take
such negative section 734(b) adjustment into account in the manner
provided in paragraph (j)(7)(iv) of this section. However, upper-tier
partnership does not treat disallowed UTP EBIE as though it were
allocated a negative section 734(b) adjustment pursuant to this
paragraph to the extent a negative section 734(b) or 743(b) adjustment
was previously made to such disallowed UTP EBIE.
(9) Determining allocable ATI and allocable business interest
income of upper-tier partnership partners--(i) In general. When
applying paragraph (f)(2)(ii) of this section, an upper-tier
partnership determines the allocable ATI and allocable business
interest income of each of its partners in the manner provided in this
paragraph. Specifically, if an upper-tier partnership's net amount of
tax items that comprise (or have ever comprised) ATI is greater than or
equal to its ATI, upper-tier partnership applies the rules in paragraph
(j)(9)(ii)(A) of this section to determine each partner's allocable
ATI. See Example 32 in paragraph (o)(32) of this section. However, if
an upper-tier partnership's net amount of tax items that comprise (or
have ever comprised) ATI is less than its ATI, upper-tier partnership
applies the rules in paragraph (j)(9)(ii)(B) of this section to
determine each partner's allocable ATI. See Example 33 in paragraph
(o)(33) of this section. To determine each partner's allocable business
interest income, an upper-tier partnership applies the rules in
paragraph (j)(9)(iii) of this section.
(ii) Upper-tier partner's allocable ATI--(A) If an upper-tier
partnership's net amount of tax items that comprise (or have ever
comprised) ATI is greater than or equal to its ATI (as determined under
Sec. 1.163(j)-1(b)(1)), then an upper-tier partner's allocable ATI
(for purposes of paragraph (f)(2)(ii) of this section) is equal to the
product of--
(1) Such partner's distributive share of gross income and gain
items that comprise (or have ever comprised) ATI, minus such partner's
distributive share of gross loss and deduction items that comprise (or
have ever comprised) ATI; multiplied by
(2) A fraction, the numerator of which is upper-tier partnership's
ATI (as determined under Sec. 163(j)-1(b)(1)), and the denominator of
which is upper-tier partnership's net amount of tax items that comprise
(or have ever comprised) ATI.
(B) If an upper-tier partnership's net amount of tax items that
comprise (or have ever comprised) ATI is less than its ATI (as
determined under Sec. 1.163(j)-1(b)(1)), then an upper-tier partner's
allocable ATI (for purposes of paragraph (f)(2)(ii) of this section) is
equal to--
(1) The excess (if any) of such partner's distributive share of
gross income and gain items that comprise (or have ever comprised) ATI,
over such partner's distributive share of gross loss and deduction
items that comprise (or have ever comprised) ATI; increased by
(2) The product of--
(i) Such partner's share of residual profits expressed as a
fraction; multiplied by
(ii) Upper-tier partnership's ATI (as determined under Sec.
1.163(j)-1(b)(1)), minus the aggregate of all the partners' amounts
determined under paragraph (j)(9)(ii)(B)(1) of this section.
(iii) Upper-tier partner's allocable business interest income. An
upper-tier partner's allocable business interest income (for purposes
of paragraph (f)(2)(ii) of this section) is equal to the product of--
(A) Such partner's distributive share of items that comprise (or
have ever comprised) business interest income; multiplied by
(B) A fraction, the numerator of which is upper-tier partnership's
business interest income (as determined under Sec. 1.163(j)-1(b)(4)),
and the denominator of which is the upper-tier partnership's amount of
items that comprise (or have ever comprised) business interest income.
* * * * *
(l) * * *
(4) * * *
(iv) S corporation deductions capitalized by an S corporation
shareholder. The ATI of an S corporation shareholder is increased by
the portion of such S corporation shareholder's allocable share of
qualified expenditures (as defined in
[[Page 56901]]
section 59(e)(2)) to which an election under section 59(e) applies.
* * * * *
(n) Treatment of self-charged lending transactions between
partnerships and partners. In the case of a lending transaction between
a partner (lending partner) and partnership (borrowing partnership) in
which the lending partner owns a direct interest (self-charged lending
transaction), any business interest expense of the borrowing
partnership attributable to the self-charged lending transaction is
business interest expense of the borrowing partnership for purposes of
this section. If in a given taxable year the lending partner is
allocated excess business interest expense from the borrowing
partnership and has interest income attributable to the self-charged
lending transaction (interest income), the lending partner is deemed to
receive an allocation of excess business interest income from the
borrowing partnership in such taxable year. The amount of the lending
partner's deemed allocation of excess business interest income is the
lesser of such lending partner's allocation of excess business interest
expense from the borrowing partnership in such taxable year or the
interest income attributable to the self-charged lending transaction in
such taxable year. To prevent the double counting of business interest
income, the lending partner includes interest income that was treated
as excess business interest income pursuant to this paragraph (n) only
once when calculating its own section 163(j) limitation. In cases where
the lending partner is not a C corporation, to the extent that any
interest income exceeds the lending partner's allocation of excess
business interest expense from the borrowing partnership for the
taxable year, and such interest income otherwise would be properly
treated as investment income of the lending partner for purposes of
section 163(d) for that year, such excess amount of interest income
will continue to be treated as investment income of the lending partner
for that year for purposes of section 163(d).
See Example 26 in paragraph (o)(26) of this section.
(o) * * *
(24) Example 24--(i) Facts. On January 1, 2020, L and M form LM,
a publicly traded partnership (as defined in Sec. 1.7704-1), and
agree that each will be allocated a 50 percent share of all LM
items. The partnership agreement provides that LM will make
allocations under section 704(c) using the remedial allocation
method under Sec. 1.704-3(d). L contributes depreciable property
with an adjusted tax basis of $4,000 and a fair market value of
$10,000. The property is depreciated using the straight-line method
with a 10-year recovery period and has 4 years remaining on its
recovery period. M contributes $10,000 in cash, which LM uses to
purchase land. Except for the depreciation deductions, LM's expenses
equal its income in each year of the 10 years commencing with the
year LM is formed. LM has a valid section 754 election in effect.
(ii) Section 163(j) remedial items and partner basis items. LM
sells the asset contributed by L in a fully taxable transaction at a
time when the adjusted basis of the property is $4,000. Under Sec.
1.163(j)-6(e)(2)(ii), solely for purposes of Sec. 1.163(j)-6, the
tax gain of $6,000 is allocated equally between L and M ($3,000
each). To avoid shifting built-in gain to the non-contributing
partner (M) in a manner consistent with the rule in section 704(c),
a remedial deduction of $3,000 is allocated to M (leaving M with no
net tax gain), and remedial income of $3,000 is allocated to L
(leaving L with total tax gain of $6,000).
(25) Example 25--(i) Facts. The facts are the same as Example 24
in paragraph (o)(24) of this section except the property contributed
by L had an adjusted tax basis of zero. For each of the 10 years
following the contribution, there would be $500 of section 704(c)
remedial income allocated to L and $500 of remedial deductions
allocated to M with respect to the contributed asset. A buyer of M's
units would step into M's shoes with respect to the $500 of annual
remedial deductions. A buyer of L's units would step into L's shoes
with respect to the $500 of annual remedial income and would have an
annual section 743(b) deduction of $1,000 (net $500 of deductions).
(ii) Analysis. Pursuant to Sec. 1.163(j)-6(d)(2)(ii), solely
for purposes of Sec. 1.163(j)-6, a buyer of L's units immediately
after formation of LM would offset its $500 annual section 704(c)
remedial income allocation with $500 of annual section 743(b)
adjustment (leaving the buyer with net $500 of section 743(b)
deduction). As a result, such buyer would be in the same position as
a buyer of M's units. Each buyer would have net deductions of $500
per year, which would not affect ATI before 2022.
(26) Example 26--(i) Facts. X and Y are partners in partnership
PRS. In Year 1, PRS had $200 of excess business interest expense.
Pursuant to Sec. 1.163(j)-6(f)(2), PRS allocated $100 of such
excess business interest expense to each of its partners. In Year 2,
X lends $10,000 to PRS and receives $1,000 of interest income for
the taxable year (self-charged lending transaction). X is not in the
trade or business of lending money. The $1,000 of interest expense
resulting from this loan is allocable to PRS's trade or business
assets. As a result, such $1,000 of interest expense is business
interest expense of PRS. X and Y are each allocated $500 of such
business interest expense as their distributive share of PRS's
business interest expense for the taxable year. Additionally, in
Year 2, PRS has $3,000 of ATI. PRS allocates the items comprising
its $3,000 of ATI $0 to X and $3,000 to Y.
(ii) Partnership-level. In Year 2, PRS's section 163(j) limit is
30 percent of its ATI plus its business interest income, or $900
($3,000 x 30 percent). Thus, PRS has $900 of deductible business
interest expense, $100 of excess business interest expense, $0 of
excess taxable income, and $0 of excess business interest income.
Pursuant to Sec. 1.163(j)-6(f)(2), $400 of X's allocation of
business interest expense is treated as deductible business interest
expense, $100 of X's allocation of business interest expense is
treated as excess business interest expense, and $500 of Y's
allocation of business interest expense is treated as deductible
business interest expense.
(iii) Lending partner. Pursuant to Sec. 1.163(j)-6(n), X treats
$100 of its $1,000 of interest income as excess business interest
income allocated from PRS in Year 2. Because X is deemed to have
been allocated $100 of excess business interest income from PRS, and
excess business interest expense from a partnership is treated as
paid or accrued by a partner to the extent excess business interest
income is allocated from such partnership to a partner, X treats its
$100 allocation of excess business interest expense from PRS in Year
2 as business interest expense paid or accrued in Year 2. X, in
computing its limit under section 163(j), has $100 of business
interest income ($100 deemed allocation of excess business interest
income from PRS in Year 2) and $100 of business interest expense
($100 allocation of excess business interest expense treated as paid
or accrued in Year 2). Thus, X's $100 of business interest expense
is deductible business interest expense. At the end of Year 2, X has
$100 of excess business interest expense from PRS ($100 from Year
1). X treats $900 of its $1,000 of interest income as investment
income for purposes of section 163(d).
(27) Example 27--(i) Formation. A, B, and C formed partnership
UTP in Year 1, each contributing $1,000 cash in exchange for a one
third interest. Also in Year 1, UTP, D, and E formed partnership
LTP, each contributing $1,200 cash in exchange for a one third
interest. LTP borrowed $9,000, resulting in each of its partners
increasing its basis in LTP by $3,000. Further, the partners of UTP
each increased their bases in UTP by $1,000 each as a result of the
LTP borrowing.
(ii) Application of section 163(j) to LTP. In Year 1, LTP's only
item of income, gain, loss, or deduction was $900 of BIE. As a
result, LTP had $900 of excess business interest expense. Pursuant
to Sec. 1.163(j)-6(f)(2), LTP allocated $300 of excess business
interest expense to each of its partners.
(iii) Section 704(b) capital account adjustments. Solely for
purposes of section 704(b) and the regulations thereunder, each
direct and indirect partner of LTP treats its allocation of excess
business interest expense from LTP as a section 705(a)(2)(B)
expenditure pursuant to Sec. 1.163(j)-6(j)(2). Further, each
indirect partner of LTP that reduced its section 704(b) capital
account as a result of the $300 allocation of excess business
interest expense to UTP is the specified partner of such UTP EBIE,
as defined in Sec. 1.163(j)-6(j)(5)(i)(B). Each partner of UTP
reduced its capital account by $100 as a result of the $300
allocation of excess business interest expense from LTP to
[[Page 56902]]
UTP. As a result, A, B, and C are each a specified partner with
respect to $100 of UTP EBIE.
(iv) Basis adjustments. Pursuant to Sec. 1.163(j)-6(h)(2), D,
E, and UTP each reduce its basis in LTP by the amount of its
allocation of excess business interest expense from LTP. As a
result, each partner's basis in its LTP interest is $3,900. Pursuant
to Sec. 1.163(j)-6(j)(3), the direct partners of UTP (A, B, and C)
do not reduce the bases of their interests in UTP as a result of the
allocation of excess business interest expense from LTP to UTP. UTP
treats its $300 allocation of excess business interest expense from
LTP as UTP EBIE, as defined in Sec. 1.163(j)-6(j)(4). At the end of
Year 1, the section 704(b) and tax basis balance sheets of LTP and
UTP are as follows:
BILLING CODE 4830-01-P
[GRAPHIC] [TIFF OMITTED] TP14SE20.014
(28) Example 28--(i) Facts. The facts are the same as Example 27
in paragraph (o)(27) of this section. In Year 2, while a section 754
election was in effect, C sold its UTP interest to D for $900. In
Year 3, LTP's only item of income, gain, loss, or deduction was $240
of income, which it allocated to UTP. Such $240 of income resulted
in $240 of excess taxable income, which LTP allocated to UTP
pursuant to Sec. 1.163(j)-f(2). Further, in Year 3, UTP's only item
of income, gain, loss, or deduction was its $240 allocation of
income from LTP. UTP allocated such $240 of income equally among its
partners. In Year 4, UTP sold its interest in LTP to X for $1,140.
(ii) Sale of specified partner's UTP interest. C's section 741
loss recognized on the sale of its partnership interest to D in Year
2 is $100 (amount realized of $900 cash, plus $1,000 relief of
liabilities, less $2,000 basis in UTP). D's initial adjusted basis
in the UTP interest acquired from C in Year 2 is $1,900 (the cash
paid for C's interest, $900, plus $1,000, D's share of UTP
liabilities). D's interest in UTP's previously taxed capital is
$1,000 ($900, the amount of cash D would receive if PRS liquidated
immediately after the hypothetical transaction, decreased by $0, the
amount of tax gain allocated to D from the hypothetical transaction,
and increased by $100, the amount of tax loss that would be
allocated to D from the hypothetical transaction). D's share of the
adjusted basis to the partnership of the partnership's property is
$2,000 ($1,000 share of previously taxed capital, plus $1,000 share
of the partnership's liabilities). Therefore, the amount of the
basis adjustment under section 743(b) to partnership property is
negative $100 (the difference between $1,900 and $2,000). D's
negative $100 section 743(b) adjustment is allocated among UTP's
assets under section 755. Under Sec. 1.755-1(b)(2), the amount of
D's
[[Page 56903]]
section 743(b) adjustment allocated to ordinary income property is
equal to the total amount of income or loss that would be allocated
to D from the sale of all ordinary income property in a hypothetical
transaction. Solely for purposes of Sec. 1.755-1(b), any UTP EBIE
is treated as ordinary income property. Thus, D's negative $100
section 743(b) basis adjustment is allocated to UTP EBIE.
(iii) Application of section 163(j) to UTP. In Year 3, UTP was
allocated excess taxable income from LTP. Thus, UTP applies the
rules in Sec. 1.163(j)-6(j)(5)(i). First, pursuant to Sec.
1.163(j)-6(j)(5)(i)(A), UTP applies the rules in Sec. 1.163(j)-6(g)
to its UTP EBIE. Because UTP was allocated $240 of excess taxable
income from LTP in Year 3, UTP treats $240 of its UTP EBIE as
business interest expense paid or accrued in Year 3. Specifically,
UTP treats $80 of each partner's share of UTP EBIE as business
interest expense paid or accrued. Under these circumstances, UTP's
method for determining which UTP EBIE is treated as business
interest expense paid or accrued is reasonable. Second, pursuant to
Sec. 1.163(j)-6(j)(5)(i)(B), UTP allocates such business interest
expense that was formerly UTP EBIE to its specified partner.
Accordingly, A and B are each allocated $80 of business interest
expense. Pursuant to Sec. 1.163(j)-6(j)(6)(i), D is treated as the
specified partner with respect to $100 of UTP EBIE (C's share of UTP
EBIE prior to the sale). Further, pursuant to Sec. 1.163(j)-
6(j)(5)(i)(A), $80 of the UTP EBIE to which D is the specified
partner was treated as business interest expense paid or accrued.
Accordingly, D is allocated such $80 of business interest expense.
After determining each partner's allocable share of section 163(j)
items used in its own section 163(j) calculation, UTP determines
each partner's allocable share of excess items pursuant to Sec.
1.163(j)-6(f)(2).
Table 62 to Paragraph (o)(28)(iii)--UTP's Application of Sec. 1.163(j)-6(f)(2)(ii) in Year 3
----------------------------------------------------------------------------------------------------------------
A B D Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI................................... $80 $80 $80 $240
Allocable BII................................... 0 0 0 0
Allocable BIE................................... 80 80 80 240
----------------------------------------------------------------------------------------------------------------
Table 63 to Paragraph (o)(28)(iii)--UTP's Application of Sec. 1.163(j)-6(f)(2)(xi) in Year 3
----------------------------------------------------------------------------------------------------------------
A B D Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE.................................. $24 $24 $24 $72
EBIE allocated.................................. 56 56 56 168
ETI allocated................................... 0 0 0 0
EBII allocated.................................. 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(iv) Treatment of business interest expense that was formerly
UTP EBIE. After determining each partner's share of deductible
business interest expense and section 163(j) excess items, UTP takes
into account any basis adjustments under section 734(b) and the
partners take into account any basis adjustments under section
743(b) to business interest expense that was formerly UTP EBIE
pursuant to Sec. 1.163(j)-6(j)(5)(i)(C). None of the UTP EBIE
treated as business interest expense paid or accrued in Year 3 was
allocated a section 734(b) adjustment. Additionally, neither A's nor
B's share of business interest expense that was formerly UTP EBIE
was allocated a section 743(b) basis adjustment. Further, neither A
nor B is a transferee specified partner, as defined in Sec.
1.163(j)-6(j)(8)(i). Therefore, no special adjustments are required
to A's or B's $24 of deductible business interest expense and $56 of
excess business interest expense. At the end of Year 3, A and B each
has an adjusted basis in UTP of $2,000 and each is the specified
partner with respect to $20 of UTP EBIE. D's share of business
interest expense that was formerly UTP EBIE was allocated a negative
$80 section 743(b) adjustment. Pursuant to Sec. 1.163(j)-
6(j)(7)(ii), D recovers $24 of the negative section 743(b)
adjustment, effectively eliminating the $24 deduction resulting from
its $24 allocation of deductible business interest expense.
Additionally, pursuant to Sec. 1.163(j)-6(j)(7)(iii), the $56 basis
decrease required under Sec. 1.163(j)-6(h)(2) for D's allocation of
excess business interest expense is reduced by the negative section
743(b) adjustment attributable to such excess business interest
expense ($56). Consequently, D does not reduce the basis of its
interest in UTP pursuant Sec. 1.163(j)-6(h)(2) upon being allocated
such excess business interest expense. As a result, D has $56 of
excess business interest expense with a basis of $0. At the end of
Year 3, D has an adjusted basis in UTP of $1,980 and is the
specified partner with respect to $20 of UTP EBIE.
(v) Application of anti-loss trafficking rules. Although D is a
transferee specified partner, as defined in Sec. 1.163(j)-6(j)(8)(i),
with respect to its $80 allocation of business interest expense from
UTP, no special basis adjustments under Sec. 1.163(j)-6(j)(8)(i) are
required because all $80 of such business interest expense was already
fully offset by negative section 743(b) adjustment. However, if such
$80 of business interest expense was not fully offset by a negative
section 743(b) adjustment, D's status as transferee specified partner
would cause such business interest expense to be fully offset by a
negative section 743(b) adjustment pursuant to Sec. 1.163(j)-
6(j)(8)(i), regardless of whether a section 754 election was not in
effect with respect to the sale of UTP from C to D. Such negative
section 743(b) adjustment would be taken into account in the manner
described in Sec. 1.163(j)-6(j)(7).
[GRAPHIC] [TIFF OMITTED] TP14SE20.015
[[Page 56904]]
BILLING CODE 4830-01-C
(vi) Sale of LTP interest. In Year 4, UTP disposed of its
interest in LTP. Thus, UTP applies the rules in Sec. 1.163(j)-
6(j)(5)(ii). First, pursuant to Sec. 1.163(j)-6(j)(5)(ii)(A), UTP
applies the rules in Sec. 1.163(j)-6(h)(3) to its UTP EBIE. Because
UTP disposed of all of its LTP interest, UTP reduces its UTP EBIE by
$60. Second, pursuant to Sec. 1.163(j)-6(j)(5)(ii)(B), UTP
increases the adjusted basis of its LTP interest by $60 (the total
amount of UTP EBIE that was reduced pursuant to Sec. 1.163(j)-
6(j)(5)(ii)(A)). Third, pursuant to Sec. 1.163(j)-6(j)(5)(ii)(C),
this $60 increase is reduced by $20 to take into account the
negative $20 section 743(b) adjustment allocated in Year 2 to the
$20 of UTP EBIE reduced pursuant to Sec. 1.163(j)-6(j)(5)(ii)(A).
As a result, UTP's adjusted basis in its LTP interest immediately
prior to the sale to X is $4,180 ($3,900 at the end of Year 1, plus
$240 allocation of income from LTP in Year 3, plus $40 increase
immediately prior to the sale attributable to the basis of UTP
EBIE). UTP's section 741 loss recognized on the sale is $40 (amount
realized of $1,140 cash, plus $3,000 relief of liabilities, less
$4,180 adjusted basis in LTP). No deduction under section 163(j) is
allowed to the UTP or X under chapter 1 of subtitle A of the Code
for any of such UTP EBIE reduced under Sec. 1.163(j)-6(h)(3).
Pursuant to Sec. 1.163(j)-6(h)(5), LTP has a Sec. 1.163(j)-6(h)(5)
basis adjustment of $40. LTP does not own property of the character
required to be adjusted. Thus, under Sec. 1.755-1(c)(4), the
adjustment is made when LTP subsequently acquires capital gain
property to which an adjustment can be made. Regardless of whether a
$20 negative section 743(b) adjustment was allocated to the $20 of
UTP EBIE reduced pursuant to Sec. 1.163(j)-6(j)(5)(ii)(A), UTP
would only increase its basis in LTP pursuant to Sec. 1.163(j)-
6(j)(5)(ii) by $40. The specified partner of such $20 of UTP EBIE is
a transferee specified partner. Therefore, it is treated as
disallowed UTP EBIE under Sec. 1.163(j)-6(j)(8)(iii) of this
section. As a result, UTP would treat such $20 of UTP EBIE for
purposes of Sec. 1.163(j)-6(j)(5)(ii) as though it were allocated a
negative section 734(b) adjustment of $20.
(29) Example 29--(i) Facts. The facts are the same as Example 27
in paragraph (o)(27) of this section. In Year 2, while a section 754
election was in effect, UTP distributed $900 to C in complete
liquidation of C's partnership interest. In Year 3, LTP's only item
of income, gain, loss, or deduction was $240 of income, which it
allocated to UTP. Such $240 of income resulted in $240 of excess
taxable income, which LTP allocated to UTP pursuant to Sec.
1.163(j)-f(2). Further, in Year 3, UTP's only item of income, gain,
loss, or deduction was its $240 allocation of income from LTP. UTP
allocated such $240 of income equally among its partners. In Year 4,
UTP sold its interest in LTP to X for $1,140.
(ii) Liquidating distribution to specified partner. C's section
731(a)(2) loss recognized on the disposition of its partnership
interest is $100 ($2,000 basis in UTP, less amount realized of $900
cash, plus $1,000 relief of liabilities). Because the election under
section 754 is in effect, UTP has a section 734(b) decrease to the
basis of its assets of $100 (the amount of section 731(a)(2) loss
recognized by C). Under section 755, the entire negative $100
section 734(b) adjustment is allocated to UTP EBIE. Following the
liquidation of C, UTP's basis in its assets ($900 of cash, plus
$3,900 interest in LTP, plus $200 basis of UTP EBIE) equals the
aggregate outside basis of partners A and B ($5,000).
(iii) Application of section 163(j) to UTP. In Year 3, UTP was
allocated excess taxable income from LTP. Thus, UTP applies the
rules in Sec. 1.163(j)-6(j)(5)(i). First, pursuant to Sec.
1.163(j)-6(j)(5)(i)(A), UTP applies the rules in Sec. 1.163(j)-6(g)
to its UTP EBIE. Because UTP was allocated $240 of excess taxable
income from LTP in Year 3, UTP treats $240 of its UTP EBIE as
business interest expense paid or accrued in Year 3. Specifically,
UTP treats $100 of A's share, $100 of B's share, and $40 of the UTP
EBIE that does not have a specified partner as business interest
expense paid or accrued. Under these circumstances, UTP's method for
determining which UTP EBIE is treated as business interest expense
paid or accrued is reasonable. Second, pursuant to Sec. 1.163(j)-
6(j)(5)(i)(B), UTP allocates such business interest expense that was
formerly UTP EBIE to its specified partner. Accordingly, each of A
and B is allocated $100 of business interest expense.
(iv) Application of anti-loss trafficking rules. Following the
liquidating distribution to C in Year 2 (a transaction described in
Sec. 1.163(j)-6(j)(6)(ii)(A)), the $100 of UTP EBIE to which C was
formerly the specified partner does not have a specified partner.
Thus, UTP does not allocate any deductible business interest expense
or excess business interest expense that was formerly C's share of
UTP EBIE to A or B. Rather, pursuant to Sec. 1.163(j)-6(j)(8)(ii),
UTP treats such business interest expense as the allocable business
interest expense, as defined in Sec. 1.163(j)-6(f)(2)(ii), of a
Sec. 1.163(j)-6(j)(8)(ii) account for purposes of applying Sec.
1.163(j)-6(f)(2). After determining each partner's allocable share
of section 163(j) items used in its own section 163(j) calculation,
UTP determines each partner's allocable share of excess items
pursuant to Sec. 1.163(j)-6(f)(2).
Table 65 to Paragraph (o)(29)(iv)--UTP's Application of Sec. 1.163(j)-6(f)(2)(ii) in Year 3
----------------------------------------------------------------------------------------------------------------
Sec. 1.163(j)-
A B 6(j)(8)(ii) account Total
----------------------------------------------------------------------------------------------------------------
Allocable ATI............................. $120 $120 $0 $240
Allocable BII............................. 0 0 0 0
Allocable BIE............................. 100 100 40 240
----------------------------------------------------------------------------------------------------------------
Table 65 to Paragraph (o)(29)(iv)--UTP's Application of Sec. 1.163(j)-6(f)(2)(xi) in Year 3
----------------------------------------------------------------------------------------------------------------
Sec. 1.163(j)-
A B 6(j)(8)(ii) account Total
----------------------------------------------------------------------------------------------------------------
Deductible BIE............................ $36 $36 $0 $72
EBIE allocated............................ 64 64 40 168
ETI allocated............................. 0 0 0 0
EBII allocated............................ 0 0 0 0
----------------------------------------------------------------------------------------------------------------
(v) Treatment of business interest expense that was formerly UTP
EBIE. After determining each partner's share of deductible business
interest expense and section 163(j) excess items, UTP takes into
account any basis adjustments under section 734(b) and the partners
take into account any basis under section 743(b) to business
interest expense that was formerly UTP EBIE pursuant to Sec.
1.163(j)-6(j)(5)(i)(C). None of the UTP EBIE treated as business
interest expense paid or accrued in Year 3 was allocated a section
743(b) adjustment. Further, neither A nor B is a transferee
specified partner, as defined in Sec. 1.163(j)-6(j)(8)(i).
Therefore, no special basis adjustments are required under Sec.
1.163(j)-6(j)(8)(i). The $40 of excess business interest expense
allocated to the Sec. 1.163(j)-6(j)(8)(ii) account is not allocated
to A or B and is not carried over by UTP. Additionally, UTP does not
have a Sec. 1.163(j)-6(h)(5) basis adjustment because such $40 of
business interest expense does not have any basis. Thus, A
[[Page 56905]]
and B each has $36 of deductible business interest expense and $64
of excess business interest expense. At the end of Year 3, A and B
each has an adjusted basis in UTP of $2,520 ($2,500 outside basis,
plus $120 allocation of income, less $36 of deductible business
interest expense, less $64 of excess business interest expense), and
neither A nor B is a specified partner with respect to any of UTP's
$60 of UTP EBIE.
Table 66 to Paragraph (o)(29)(v)--UTP EBIE--End of Year 3
----------------------------------------------------------------------------------------------------------------
Specified partner Partnership
--------------------------------- -------------------------------
Basis Carryforward Basis Carryforward
----------------------------------------------------------------------------------------------------------------
A............................ $0 $0 UTP............. $0 $60
B............................ 0 0 .............. ..............
Sec. 1.163(j)-6(j)(8)(ii) 0 60 .............. ..............
account.
--------------------------------- -------------------------------
Total.................... 0 60 Total........ 0 60
----------------------------------------------------------------------------------------------------------------
(vi) Sale of LTP interest. In Year 4, UTP disposed of its
interest in LTP. Thus, UTP applies the rules in Sec. 1.163(j)-
6(j)(5)(ii). First, pursuant to Sec. 1.163(j)-6(j)(5)(ii)(A), UTP
applies the rules in Sec. 1.163(j)-6(h)(3) to its UTP EBIE. Because
UTP disposed of all of its LTP interest, UTP reduces its UTP EBIE by
$60. Second, pursuant to Sec. 1.163(j)-6(j)(5)(ii)(B), UTP
increases the adjusted basis of its LTP interest by $60 (the total
amount of UTP EBIE that was reduced pursuant to Sec. 1.163(j)-
6(j)(5)(ii)(A)). Third, pursuant to Sec. 1.163(j)-6(j)(5)(ii)(C),
this $60 increase is reduced by $60 to take into account the
negative $60 section 734(b) adjustment allocated in Year 2 to the
$60 of UTP EBIE reduced pursuant to Sec. 1.163(j)-6(j)(5)(ii)(A).
As a result, UTP's adjusted basis in its LTP interest immediately
prior to the sale to X is $4,140 ($3,900 at the end of Year 1, plus
$240 allocation of income from LTP in Year 3). UTP has no section
741 gain or loss recognized on the sale (amount realized of $1,140
cash, plus $3,000 relief of liabilities, equals $4,140 adjusted
basis in LTP). No deduction under section 163(j) is allowed to the
UTP or X under chapter 1 of subtitle A of the Code for any of such
UTP EBIE reduced under Sec. 1.163(j)-6(h)(3). Regardless of whether
the $60 of UTP EBIE's basis was reduced by a $60 negative section
734(b) adjustment, UTP would not increase its basis in LTP pursuant
to Sec. 1.163(j)-6(j)(5)(ii) of this section as a result of the
sale to X. The $60 of UTP EBIE does not have a specified partner.
Therefore, it is treated as disallowed UTP EBIE under Sec.
1.163(j)-6(j)(8)(iii) of this section. As a result, UTP would treat
such $60 of UTP EBIE for purposes of Sec. 1.163(j)-6(j)(5)(ii) as
though it were allocated a negative section 734(b) adjustment of
$60.
(30) Example 30--(i) X, Y and Z are partners in partnership PRS,
PRS and A are partners in UTP, and UTP is a partner in LTP. LTP
allocates $15 of excess business interest expense to UTP. Pursuant
to Sec. 1.163(j)-6(j)(2), UTP reduces its section 704(b) capital
account (capital account) in LTP by $15, A reduces its capital
account in UTP by $5, PRS reduces its capital account in UTP by $10,
X reduces its capital account in PRS by $4, and Y reduces its
capital account in PRS by $6. Thus, A, PRS, X, and Y are the
specified partner with respect to $5, $10, $4, and $6 of UTP EBIE,
respectively.
(ii) Assume the same facts in (i) except that PRS distributed
cash to Y in complete liquidation of Y's interest in PRS. As a
result, pursuant to Sec. 1.163(j)-6(j)(6)(ii)(A), Y's share of UTP
EBIE would not have a specified partner. In a subsequent year, if
LTP allocated UTP $15 of excess business interest income, UTP would
apply the rules in Sec. 1.163(j)-6(j)(5)(i) and allocate $5 of
deductible business interest expense to A and $10 of deductible
business interest expense to PRS (the specified partners of such
deductible business interest expense). Because the $10 of deductible
business interest expense allocated to PRS was formerly UTP EBIE,
PRS must also apply the rules in Sec. 1.163(j)-6(j)(5)(i). PRS
would allocate $4 of such deductible business interest expense to X
(the specified partner of such $4). However, as a result of the
liquidating distribution to Y, the remaining $6 of deductible
business interest expense does not have a specified partner. Thus,
pursuant to Sec. 1.163(j)-6(j)(8)(ii), PRS would make a Sec.
1.163(j)-6(h)(5) basis adjustment to its property in the amount of
the adjusted basis (if any) of such $6 of deductible business
interest expense.
(iii) Assume the same facts as in (i) except that PRS
distributed its interest in UTP to Y in complete liquidation of Y's
interest in PRS. Pursuant to Sec. 1.163(j)-6(j)(6)(ii)(A), Y is the
specified partner with respect to UTP EBIE of UTP only to the same
extent it was prior to the distribution ($6). As a result, the UTP
EBIE of UTP in excess of the UTP EBIE for which Y is the specified
partner (X's $4) does not have a specified partner. If in a
subsequent year LTP allocated UTP $15 of excess business interest
income, UTP would apply the rules in Sec. 1.163(j)-6(j)(5)(i) and
allocate $5 of deductible business interest expense to A and $6 of
deductible business interest expense to Y. Regarding the $4 of DBIE
without a specified partner, UTP would apply the rules in Sec.
1.163(j)-6(j)(8)(ii) and make a Sec. 1.163(j)-6(h)(5) basis
adjustment to its property in the amount of the adjusted basis (if
any) of such $4 of deductible business interest expense.
(iv) Assume the same facts as in (i) except that A contributes
its UTP interest to a new partnership, PRS2. Following the
contribution, PRS2 is treated as the specified partner with respect
to the portion of the UTP EBIE attributable to the contributed
interest ($5). Further, A continues to be the specified partner with
respect to the UTP EBIE attributable to the contributed interest
($5). If in a subsequent year LTP allocated UTP $15 of excess
business interest income, UTP would apply the rules in Sec.
1.163(j)-6(j)(5)(i) and allocate $5 of deductible business interest
expense to PRS2, and PRS2 would allocate such $5 of deductible
business interest expense to A.
(31) Example 31--(i) Facts. In Year 1, A, B, and C formed
partnership PRS by each contributing $1,000 cash. PRS borrowed $900,
causing each partner's basis in PRS to increase by $300 under
section 752. Also in Year 1, PRS purchased Capital Asset X for $200.
In Year 2, PRS pays $300 of business interest expense, all of which
is disallowed and treated as excess business interest expense. PRS
allocated the $300 of excess business interest expense to its
partners, $100 each. Pursuant to Sec. 1.163(j)-6(h)(2), each
partner reduced its adjusted basis in its PRS interest by its $100
allocation of excess business interest expense to $1,200. In Year 3,
when the fair market value of Capital Asset X is $3,200 and no
partner's basis in PRS has changed, PRS distributed $1,900 to C in
complete liquidation of C's partnership interest in a distribution
to which section 737 does not apply. PRS had a section 754 election
in effect in Year 3.
(ii) Consequences to selling partner. Pursuant to Sec.
1.163(j)-6(h)(3), C increases the adjusted basis of its interest in
PRS by $100 immediately before the disposition. Thus, C's section
731(a)(1) gain recognized on the disposition of its interest in PRS
is $900 (($1,900 cash + $300 relief of liabilities) - ($1,200
outside basis + $100 excess business interest expense add-back)).
(iii) Partnership basis. Pursuant to Sec. 1.163(j)-6(h)(5), PRS
has a $100 increase to the basis of its assets attributable to a
Sec. 1.163(j)-6(h)(5) basis increase immediately before C's
disposition. Under section 755, the entire $100 adjustment is
allocated to Capital Asset X. Pursuant to Sec. 1.163(j)-6(h)(5),
regardless of whether Capital Asset X is a depreciable or
amortizable asset, none of the $100 of Sec. 1.163(j)-6(h)(5) basis
increase allocated to Capital Asset X is depreciable or amortizable.
Additionally, PRS has a section 734(b) increase to the basis of its
assets of $900 (the amount of section 731(a)(1) gain recognized by
C). Under section 755, the entire $900 adjustment is allocated to
Capital Asset X. As a result, PRS's basis in Capital Asset X is
$1,200 ($200 + $100 Sec. 1.163(j)-6(h)(5) basis increase + $900
section 734(b) adjustment). Following the liquidation of C, PRS's
basis in its assets ($600 cash + $1,200
[[Page 56906]]
Capital Asset X) equals the aggregate adjusted basis of partners A
and B in PRS ($1,800).
(32) Example 32--(i) Facts. X and Y are equal partners in
partnership UTP, which is a partner in partnership LTP. In Year 1,
LTP allocated $100 of income to UTP. LTP, in computing its limit
under section 163(j), treated such $100 of income as ATI.
Accordingly, in LTP's Sec. 1.163(j)-6(f)(2)(ii) calculation, UTP's
allocable ATI was $100. Additionally, pursuant to Sec. 1.163(j)-
6(f)(2), LTP allocated $50 of excess taxable income to UTP. UTP's
only items of income, gain, loss or deduction in Year 1, other than
the $100 allocation from LTP, were $100 of trade or business income
and $30 of business interest expense. UTP allocated its $200 of
income and gain items $100 to X and $100 to Y, and all $30 of its
business interest expense to X.
(ii) Partnership-level. Pursuant to Sec. 1.163(j)-6(e)(1), UTP,
in computing its limit under section 163(j), does not increase or
decrease any of its section 163(j) items by any of LTP's section
163(j) items. Pursuant to Sec. 1.163(j)-1(b)(1), UTP determines it
has $150 of ATI in Year 1 ($100 of ATI resulting from its $100 of
trade or business income, plus $50 of excess taxable income from
LTP). UTP's section 163(j) limit is 30 percent of its ATI, or $45
($150 x 30 percent). Thus, UTP has $50 of excess taxable income and
$30 of deductible business interest expense.
(iii) Partner-level allocations. UTP allocates its $50 of excess
taxable income and $30 of deductible business interest expense to X
and Y pursuant to Sec. 1.163(j)-6(f)(2). To determine each
partner's share of the $50 of excess taxable income, UTP must
determine each partner's allocable ATI and allocable business
interest expense (as defined in Sec. 1.163(j)-6(f)(2)(ii)). X's
allocable business interest expense is $30 and Y's allocable
business interest expense is $0. Because UTP is an upper-tier
partnership, UTP determines the allocable ATI of each of its
partners in the manner provided in Sec. 1.163(j)-6(j)(9).
Specifically, because UTP's net amount of tax items that comprise
(or have ever comprised) ATI is $200 ($100 of trade or business
income that UTP treated as ATI, plus UTP's $100 allocation from LTP
of items that comprised ATI to LTP), which is greater than its $150
of ATI, UTP must apply the rules in Sec. 1.163(j)-6(j)(9)(ii)(A) to
determine each of its partner's allocable ATI. UTP determines X's
allocable ATI is $75 (X's $100 distributive share of gross income
and gain items that comprise (or have ever comprised) ATI,
multiplied by ($150/$200), the ratio of UTP's ATI to its tax items
that comprise (or have ever comprised) ATI). In a similar manner,
UTP determines Y's allocable ATI also equals $75. Therefore,
pursuant to Sec. 1.163(j)-6(f)(2), X is allocated $30 of deductible
business interest expense and Y is allocated $50 of excess taxable
income.
(33) Example 33--(i) Facts. X and Y are equal partners in
partnership UTP, which is a partner in partnership LTP. Further, X
and Y share the residual profits of UTP equally. In Year 1, LTP
allocated ($99) of income to UTP. LTP, in computing its limit under
section 163(j), treated such ($99) of income as ATI. Accordingly, in
LTP's Sec. 1.163(j)-6(f)(2)(ii) calculation, UTP's allocable ATI
was ($99). UTP's only items of income, gain, loss or deduction in
Year 1, other than the ($99) allocation from LTP, were $100 of trade
or business income and $15 of business interest expense. UTP
allocated $1 of income to X and $0 to Y pursuant to section 704(c),
the ($99) of loss and remaining $99 of income equally pursuant to
section 704(b), and all $15 of its business interest expense to X.
(ii) Partnership-level. Pursuant to Sec. 1.163(j)-6(e)(1), UTP,
in computing its limit under section 163(j), does not increase or
decrease any of its section 163(j) items by any of LTP's section
163(j) items. Pursuant to Sec. 1.163(j)-1(b)(1), UTP determines it
has $100 of ATI in Year 1 ($100 of ATI resulting from its $100 of
trade or business income). UTP's section 163(j) limit is 30 percent
of its ATI, or $30 ($100 x 30 percent). Thus, UTP has $50 of excess
taxable income and $15 of deductible business interest expense.
(iii) Partner-level allocations. UTP allocates its $50 of excess
taxable income and $15 of deductible business interest expense to X
and Y pursuant to Sec. 1.163(j)-6(f)(2). To determine each
partner's share of the $50 of excess taxable income, UTP must
determine each partner's allocable ATI and allocable business
interest expense (as defined in Sec. 1.163(j)-6(f)(2)(ii)). X's
allocable business interest expense is $15 and Y's allocable
business interest expense is $0. Because UTP is an upper-tier
partnership, UTP determines the allocable ATI of each of its
partners in the manner provided in Sec. 1.163(j)-6(j)(9).
Specifically, because UTP's net amount of tax items that comprise
(or have ever comprised) ATI is $1 ($100 of trade or business income
that UTP treated as ATI, plus UTP's ($99) allocation from LTP of
items that comprised ATI to LTP), which is less than its $100 of
ATI, UTP must apply the rules in Sec. 1.163(j)-6(j)(9)(ii)(B) to
determine each of its partner's allocable ATI. UTP determines X's
allocable ATI is $50.50 ($1, which is the excess of X's distributive
share of gross income and gain items that comprise (or have ever
comprised) ATI, $100, over X's distributive share of gross loss and
deduction items that comprise (or have ever comprised) ATI, $99;
increased by $49.50, which is the product of 50 percent, X's
residual profit sharing percentage, and $99, UTP's $100 of ATI minus
$1, which is the aggregate of all the partners' amounts determined
under Sec. 1.163(j)-6(j)(9)(ii)(B)(1)). In a similar manner, UTP
determines Y's allocable ATI is $49.50. Therefore, pursuant to Sec.
1.163(j)-6(f)(2), X is allocated $15 of deductible business interest
expense and $0.50 of excess taxable income, and Y is allocated
$49.50 of excess taxable income.
(34) Example 34--(i) Facts. X and Y are equal partners in
partnership PRS. Further, X and Y share the profits of PRS equally.
In 2019, PRS had ATI of $100. In 2020, PRS's only items of income,
gain, loss or deduction was $1 of trade or business income, which it
allocated to X pursuant to section 704(c).
(ii) Partnership-level. In 2020, PRS makes the election
described in Sec. 1.163(j)-6(d)(5) to use its 2019 ATI in 2020. As
a result, PRS has $100 of ATI in 2020. PRS does not have any
business interest expense. Therefore, PRS has $100 of excess taxable
income in 2020.
(iii) Partner-level allocations. PRS allocates its $100 of
excess taxable income to X and Y pursuant to Sec. 1.163(j)-6(f)(2).
To determine each partner's share of the $100 of excess taxable
income, PRS must determine each partner's allocable ATI (as defined
in Sec. 1.163(j)-6(f)(2)(ii)). Because PRS made the election
described in Sec. 1.163(j)-6(d)(5), PRS must determine the
allocable ATI of each of its partners pursuant to paragraph (j)(9)
of this section in the same manner as an upper-tier partnership.
Specifically, because PRS's amount of tax items that comprise ATI
before the election is $1, which is less than its $100 of ATI
following the election, PRS must apply the rules in Sec. 1.163(j)-
6(j)(9)(ii)(B) to determine each of its partner's allocable ATI. PRS
determines X's allocable ATI is $50.50 ($1, which is the excess of
X's distributive share of gross income and gain items that would
have comprised ATI had PRS not made the election, $1, over X's
distributive share of gross loss and deduction items that would have
comprised ATI had PRS not made the election, $0; increased by
$49.50, which is the product of 50%, X's residual profit share, and
$99, PRS's $100 of ATI minus $1, the aggregate of all the partners'
amounts determined under Sec. 1.163(j)-6(j)(9)(ii)(B)(1)). In a
similar manner, PRS determines Y's allocable ATI is $49.50.
Therefore, pursuant to Sec. 1.163(j)-6(f)(2), X is allocated $50.50
of excess taxable income, and Y is allocated $49.50 of excess
taxable income.
(35) Example 35--(i) Facts. X, a partner in partnership PRS, was
allocated $20 of excess business interest expense from PRS in 2018
and $10 of excess business interest expense from PRS in 2019. In
2020, PRS allocated $16 of excess taxable income to X.
(ii) Analysis. X treats 50 percent of its $10 of excess business
interest expense allocated from PRS in 2019 as Sec. 1.163(j)-
6(g)(4) business interest expense. Thus, $5 of Sec. 1.163(j)-
6(g)(4) business interest expense is treated as paid or accrued by X
in 2020 and is not subject to the section 163(j) limitation at X's
level. Because X was allocated $16 of excess taxable income from PRS
in 2020, X treats $16 of its $25 of excess business interest expense
as business interest expense paid or accrued pursuant to Sec.
1.163(j)-6(g)(2). X, in computing its limit under section 163(j) in
2020, has $16 of ATI (as a result of its allocation of $16 of excess
taxable income from PRS), $0 of business interest income, and $16 of
business interest expense ($16 of excess business interest expense
treated as paid or accrued in 2020). Pursuant to Sec. 1.163(j)-
2(b)(2)(i), X's section 163(j) limit in 2020 is $8 ($16 x 50
percent). Thus, X has $8 of business interest expense that is
deductible under section 163(j). The $8 of X's business interest
expense not allowed as a deduction ($16 business interest expense
subject to section 163(j), less $8 section 163(j) limit) is treated
as business interest expense paid or accrued by X in 2021. At the
end of 2020, X has $9 of excess business interest expense from PRS
($20 from 2018, plus $10 from 2019, less $5 treated as paid or
accrued pursuant to Sec. 1.163(j)-6(g)(4), less $16 treated as paid
or accrued pursuant to Sec. 1.163(j)-6(g)(2)).
(36) Example 36--(i) Facts. X is a partner in partnership PRS.
At the beginning of 2018, X's outside basis in PRS was $100. X was
[[Page 56907]]
allocated $20 of excess business interest expense from PRS in 2018
and $10 of excess business interest expense from PRS in 2019. X sold
its PRS interest in 2019 for $70.
(ii) Analysis. X treats 50 percent of its $10 of excess business
interest expense allocated from PRS in 2019 as Sec. 1.163(j)-
6(g)(4) business interest expense. Thus, $5 of Sec. 1.163(j)-
6(g)(4) business interest expense is treated as paid or accrued by X
in 2020 and is not subject to the section 163(j) limitation at X's
level. Pursuant to paragraph (h)(3) of this section, immediately
before the disposition, X increases the basis of its PRS interest to
$95. Thus, X has a $25 section 741 loss recognized on the sale ($70-
$95).
(p) Applicability dates--(1) In general. * * *
(2) Paragraphs (c)(1) and (2), (d)(3) through (5), (e)(5) and (6),
(f)(1)(iii), (g)(4), (h)(4) and (5), (j), (l)(4)(iv), (n), and (o)(24)
through (29). Paragraphs (c)(1) and (2), (d)(3) through (5), (e)(5) and
(6), (f)(1)(iii), (g)(4), (h)(4) and (5), (j), (l)(4)(iv), (n), and
(o)(24) through (29) of this section apply to taxable years beginning
on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE
IN THE FEDERAL REGISTER]. However, taxpayers and their related parties,
within the meaning of sections 267(b) and 707(b)(1), may choose to
apply the rules of those paragraphs to a taxable year beginning after
December 31, 2017, and before [DATE 60 DAYS AFTER DATE OF PUBLICATION
OF THE FINAL RULE IN THE FEDERAL REGISTER], provided that they also
apply the provisions of Sec. 1.163(j)-6 in the section 163(j)
regulations, and consistently apply all of the rules of Sec. 1.163(j)-
6 in the section 163(j) regulations to that taxable year and to each
subsequent taxable year.
* * * * *
0
Par. 8. As added in a final rule elsewhere in this issue of the Federal
Register, effective November 13, 2020, Sec. 1.163(j)-7 is amended by
revising paragraph (a), adding paragraphs (c) through (f), (g)(3) and
(4), (h), and (j) through (l), and revising paragraph (m) to read as
follows:
Sec. 1.163(j)-7 Application of the section 163(j) limitation to
foreign corporations and United States shareholders.
(a) Overview. This section provides rules for the application of
section 163(j) to relevant foreign corporations and United States
shareholders of relevant foreign corporations. Paragraph (b) of this
section provides the general rule regarding the application of section
163(j) to a relevant foreign corporation. Paragraph (c) of this section
provides rules for applying section 163(j) to CFC group members of a
CFC group. Paragraph (d) of this section provides rules for determining
a specified group and specified group members. Paragraph (e) of this
section provides rules and procedures for treating a specified group
member as a CFC group member and for determining a CFC group. Paragraph
(f) of this section provides rules regarding the treatment of a CFC
group member that has ECI. Paragraph (g) of this section provides rules
concerning the computation of ATI of an applicable CFC. Paragraph (h)
of this section provides a safe-harbor that exempts certain stand-alone
applicable CFCs and CFC groups from the application of section 163(j)
for a taxable year. Paragraph (i) of this section is reserved.
Paragraph (j) of this section provides rules concerning the computation
of ATI of a United States shareholder of an applicable CFC. Paragraph
(k) of this section provides definitions that apply for purposes of
this section. Paragraph (l) of this section provides examples
illustrating the application of this section.
* * * * *
(c) Application of section 163(j) to CFC group members of a CFC
group--(1) Scope. This paragraph (c) provides rules for applying
section 163(j) to a CFC group member. Paragraph (c)(2) of this section
provides rules for computing a single section 163(j) limitation for a
specified period of a CFC group. Paragraph (c)(3) of this section
provides rules for allocating a CFC group's section 163(j) limitation
to CFC group members for specified taxable years. Paragraph (c)(4) of
this section provides currency translation rules. Paragraph (c)(5) of
this section provides special rules for specified periods beginning in
2019 or 2020.
(2) Calculation of section 163(j) limitation for a CFC group for a
specified period--(i) In general. A single section 163(j) limitation is
computed for a specified period of a CFC group. For purposes of
applying section 163(j) and the section 163(j) regulations, the
current-year business interest expense, disallowed business interest
expense carryforwards, business interest income, floor plan financing
interest expense, and ATI of a CFC group for a specified period equal
the sums of each CFC group member's respective amounts for its
specified taxable year with respect to the specified period. A CFC
group member's current-year business interest expense, business
interest income, floor plan financing interest expense, and ATI for a
specified taxable year are generally determined on a separate-company
basis.
(ii) Certain transactions between CFC group members disregarded.
Any transaction between CFC group members of a CFC group that is
entered into with a principal purpose of affecting a CFC group or a CFC
group member's section 163(j) limitation by increasing or decreasing a
CFC group or a CFC group member's ATI for a specified taxable year is
disregarded for purposes of applying section 163(j) and the section
163(j) regulations.
(iii) CFC group treated as a single C corporation for purposes of
allocating items to an excepted trade or business. For purposes of
allocating items to an excepted trade or business under Sec. 1.163(j)-
10, all CFC group members of a CFC group are treated as a single C
corporation.
(iv) CFC group treated as a single taxpayer for purposes of
determining interest. For purposes of determining whether amounts,
other than amounts in respect of transactions between CFC group members
of a CFC group, are treated as interest within the meaning of Sec.
1.163(j)-1(b)(22), all CFC group members of a CFC group are treated as
a single taxpayer.
(3) Deduction of business interest expense--(i) CFC group business
interest expense--(A) In general. The extent to which a CFC group
member's current-year business interest expense and disallowed business
interest expense carryforwards for a specified taxable year that ends
with or within a specified period may be deducted under section 163(j)
is determined under the rules and principles of Sec. 1.163(j)-5(a)(2)
and (b)(3)(ii), subject to the modifications described in paragraph
(c)(3)(i)(B) of this section.
(B) Modifications to relevant terms. For purposes of paragraph
(c)(3)(i)(A) of this section, the rules and principles of Sec.
1.163(j)-5(b)(3)(ii) are applied by--
(1) Replacing ``Sec. 1.163(j)-4(d)(2)'' in Sec. 1.163(j)-
5(a)(2)(ii) with ``Sec. 1.163(j)-7(c)(2)(i)'';
(2) Replacing the term ``allocable share of the consolidated
group's remaining section 163(j) limitation'' with ``allocable share of
the CFC group's remaining section 163(j) limitation'';
(3) Replacing the terms ``consolidated group'' and ``group'' with
``CFC group'';
(4) Replacing the term ``consolidated group's remaining section
163(j) limitation'' with ``CFC group's remaining section 163(j)
limitation'';
(5) Replacing the term ``consolidated return year'' with
``specified period'';
(6) Replacing the term ``current year'' or ``current-year'' with
``current specified period'' or ``specified taxable year with respect
to the current specified period,'' as the context requires;
[[Page 56908]]
(7) Replacing the term ``member'' with ``CFC group member''; and
(8) Replacing the term ``taxable year'' with ``specified taxable
year with respect to a specified period.''
(ii) Carryforwards treated as attributable to the same taxable
year. For purposes of applying the principles of Sec. 1.163(j)-
5(b)(3)(ii), as required under paragraph (c)(3)(i) of this section, CFC
group members' disallowed business interest expense carryforwards that
arose in specified taxable years with respect to the same specified
period are treated as disallowed business interest expense
carryforwards from taxable years ending on the same date and are
deducted on a pro rata basis, under the principles of Sec. 1.163(j)-
5(b)(3)(ii)(C)(3), pursuant to paragraph (c)(3)(i) of this section.
(iii) Multiple specified taxable years of a CFC group member with
respect to a specified period. If a CFC group member has more than one
specified taxable year (each year, an applicable specified taxable
year) with respect to a single specified period of a CFC group, then
all such applicable specified taxable years are taken into account for
purposes of applying the principles of Sec. 1.163(j)-5(b)(3)(ii), as
required under paragraph (c)(3)(i) of this section, with respect to the
specified period. The portion of the section 163(j) limitation
allocable to disallowed business interest expense carryforwards of the
CFC group member for its applicable specified taxable years is prorated
among the applicable specified taxable years in proportion to the
number of days in each applicable specified taxable year.
(iv) Limitation on pre-group disallowed business interest expense
carryforward--(A) General rule--(1) CFC group member pre-group
disallowed business interest expense carryforward. This paragraph
(c)(3)(iv) applies to pre-group disallowed business interest expense
carryforwards of a CFC group member. The amount of the pre-group
disallowed business interest expense carryforwards described in the
preceding sentence that are included in any CFC group member's business
interest expense deduction for any specified taxable year under this
paragraph (c)(3) may not exceed the aggregate section 163(j) limitation
for all specified periods of the CFC group, determined by reference
only to the CFC group member's items of income, gain, deduction, and
loss, and reduced (including below zero) by the CFC group member's
business interest expense (including disallowed business interest
expense carryforwards) taken into account as a deduction by the CFC
group member in all specified taxable years in which the CFC group
member has continuously been a CFC group member of the CFC group
(cumulative section 163(j) pre-group carryforward limitation).
(2) Subgrouping. In the case of a CFC group member with a pre-group
disallowed business interest expense carryforward (the loss member)
that joined the CFC group (the current group) for a specified taxable
year with respect to a specified period (the relevant period), if the
loss member was a CFC group member of a different CFC group (the former
group) immediately prior to joining the current group, a pre-group
subgroup is composed of the loss member and each other CFC group member
that became a CFC group member of the current group for a specified
taxable year with respect to the relevant period and was a member of
the former group immediately prior to joining the current group. For
purposes of this paragraph (c), the rules and principles of Sec.
1.163(j)-5(d)(1)(B) apply to a pre-group subgroup as if the pre-group
subgroup were a SRLY subgroup.
(B) Deduction of pre-group disallowed business interest expense
carryforwards. Notwithstanding paragraph (c)(3)(iv)(A)(1) of this
section, pre-group disallowed business interest expense carryforwards
are available for deduction by a CFC group member in its specified
taxable year only to the extent the CFC group has remaining section
163(j) limitation for the specified period after the deduction of
current-year business interest expense and disallowed business interest
expense carryforwards from earlier taxable years that are permitted to
be deducted in specified taxable years of CFC group members with
respect to the specified period. See paragraph (c)(3)(i) of this
section and Sec. 1.163(j)-5(b)(3)(ii)(A). Pre-group disallowed
business interest expense carryforwards are deducted on a pro rata
basis (under the principles of paragraph (c)(3)(i) of this section and
Sec. 1.163(j)-5(b)(3)(ii)(C)(3)) with other disallowed business
interest expense carryforwards from taxable years ending on the same
date.
(4) Currency translation. For purposes of applying this paragraph
(c), items of a CFC group member are translated into a single currency
for the CFC group and back to the functional currency of the CFC group
member using the average rate for the CFC group member's specified
taxable year, using any reasonable method, consistently applied. The
single currency for the CFC group may be the U.S. dollar or the
functional currency of a plurality of the CFC group members.
(5) Special rule for specified periods beginning in 2019 or 2020--
(i) 50 percent ATI limitation applies to a specified period of a CFC
group. In the case of a CFC group, Sec. 1.163(j)-2(b)(2) (including
the election under Sec. 1.163(j)-2(b)(2)(ii)) applies to a specified
period of the CFC group beginning in 2019 or 2020, rather than to a
specified taxable year of a CFC group member. An election under Sec.
1.163(j)-2(b)(2)(ii) for a specified period of a CFC group is not
effective unless made by each designated U.S. person. Except as
otherwise provided in this paragraph (c)(5)(i), the election is made in
accordance with Revenue Procedure 2020-22, 2020-18 I.R.B. 745. For
purposes of applying Sec. 1.964-1(c), the election is treated as if
made for each CFC group member.
(ii) Election to use 2019 ATI applies to a specified period of a
CFC group--(A) In general. In the case of a CFC group, for purposes of
applying paragraph (c)(2) of this section, an election under Sec.
1.163(j)-2(b)(3)(i) is made for a specified period of a CFC group
beginning in 2020 and applies to the specified taxable years of each
CFC group member with respect to such specified period, taking into
account the application of paragraph (c)(5)(ii)(B) of this section. The
election under Sec. 1.163(j)-2(b)(3)(i) does not apply to any
specified taxable year of a CFC group member other than those described
in the preceding sentence. An election under Sec. 1.163(j)-2(b)(3)(i)
for a specified period of a CFC group is not effective unless made by
each designated U.S. person. Except as otherwise provided in this
paragraph (c)(5)(ii)(A), the election is made in accordance with
Revenue Procedure 2020-22, 2020-18 I.R.B. 745. For purposes of applying
Sec. 1.964-1(c), the election is treated as if made for each CFC group
member.
(B) Specified taxable years that do not begin in 2020. If a
specified taxable year of a CFC group member with respect to the
specified period described in paragraph (c)(5)(ii)(A) of this section
begins in 2019, then, for purposes of applying paragraph (c)(2) of this
section, Sec. 1.163(j)-2(b)(3) is applied to such specified taxable
year by substituting ``2018'' for ``2019'' and ``2019'' for ``2020.''
If a specified taxable year of a CFC group member with respect to the
specified period described in paragraph (c)(5)(ii)(A) of this section
begins in 2021, then, for purposes of applying paragraph (c)(2) of this
section, Sec. 1.163(j)-2(b)(3) is applied to such specified taxable
year by substituting ``2020'' for ``2019'' and ``2021'' for ``2020.''
[[Page 56909]]
(d) Determination of a specified group and specified group
members--(1) Scope. This paragraph (d) provides rules for determining a
specified group and specified group members. Paragraph (d)(2) of this
section provides rules for determining a specified group. Paragraph
(d)(3) of this section provides rules for determining specified group
members.
(2) Rules for determining a specified group--(i) Definition of a
specified group. Subject to paragraph (d)(2)(ii) of this section, the
term specified group means one or more chains of applicable CFCs
connected through stock ownership with a specified group parent (which
is included in the specified group only if it is an applicable CFC),
but only if--
(A) The specified group parent owns directly or indirectly stock
meeting the requirements of section 1504(a)(2)(B) in at least one
applicable CFC; and
(B) Stock meeting the requirements of section 1504(a)(2)(B) in each
of the applicable CFCs (except the specified group parent) is owned
directly or indirectly by one or more of the other applicable CFCs or
the specified group parent.
(ii) Indirect ownership. For purposes of applying paragraph
(d)(2)(i) of this section, stock is owned indirectly only if it is
owned under section 318(a)(2)(A) through a partnership or under section
318(a)(2)(A) or (B) through an estate or trust not described in section
7701(a)(30).
(iii) Specified group parent. The term specified group parent means
a qualified U.S. person or an applicable CFC.
(iv) Qualified U.S. person. The term qualified U.S. person means a
United States person described in section 7701(a)(30)(A) or (C). For
purposes of this paragraph (d), members of a consolidated group that
file (or that are required to file) a consolidated U.S. federal income
tax return are treated as a single qualified U.S person and individuals
described in section 7701(a)(30)(A) whose filing status is married
filing jointly are treated as a single qualified U.S. person.
(v) Stock. For purposes of paragraph (d)(3)(i) of this section, the
term stock has the same meaning as ``stock'' in section 1504 (without
regard to Sec. 1.1504-4, except as provided in paragraph (d)(2)(vi) of
this section) and all shares of stock within a single class are
considered to have the same value. Thus, control premiums and minority
and blockage discounts within a single class are not taken into
account.
(vi) Options treated as exercised. For purposes of this paragraph
(d)(2), options that are reasonably certain to be exercised, as
determined under Sec. 1.1504-4(g), are treated as exercised. For
purposes of this paragraph (d)(2)(vi), options include call options,
warrants, convertible obligations, put options, and any other
instrument treated as an option under Sec. 1.1504-4(d), determined by
replacing the term ``a principal purpose of avoiding the application of
section 1504 and this section'' with ``a principal purpose of avoiding
the application of section 163(j).''
(vii) When a specified group ceases to exist. The principles of
Sec. 1.1502-75(d)(1), (d)(2)(i) through (d)(2)(ii), and (d)(3)(i)
through (d)(3)(iv), apply for purposes of determining when a specified
group ceases to exist. Solely for purposes of applying these
principles, each applicable CFC that is treated as a specified group
member for a taxable year with respect to a specified period is treated
as affiliated with the specified group parent from the beginning to the
end of the specified period, without regard to the beginning or end of
its taxable year.
(3) Rules for determining a specified group member. If an
applicable CFC is included in a specified group on the last day of a
taxable year of the applicable CFC that ends with or within a specified
period, the applicable CFC is a specified group member with respect to
the specified period for its entire taxable year ending with or within
the specified period. If an applicable CFC has multiple taxable years
that end with or within a specified period, this paragraph (d)(3) is
applied separately to each taxable year to determine if the applicable
CFC is a specified group member for such taxable year.
(e) Rules and procedures for treating a specified group as a CFC
group--(1) Scope. This paragraph (e) provides rules and procedures for
treating a specified group member as a CFC group member and for
determining a CFC group for purposes of applying section 163(j) and the
section 163(j) regulations.
(2) CFC group and CFC group member--(i) CFC group. The term CFC
group means, with respect to a specified period, all CFC group members
for their specified taxable years.
(ii) CFC group member. The term CFC group member means, with
respect to a specified taxable year and a specified period, a specified
group member of a specified group for which a CFC group election is in
effect.
(3) Duration of a CFC group. A CFC group continues until the CFC
group election is revoked, or there is no longer a specified period
with respect to the specified group.
(4) Joining or leaving a CFC group. If an applicable CFC becomes a
specified group member for a specified taxable year with respect to a
specified period of a specified group for which a CFC group election is
in effect, the CFC group election applies to the applicable CFC and the
applicable CFC becomes a CFC group member. If an applicable CFC ceases
to be a specified group member for a specified taxable year with
respect to a specified period of a specified group for which a CFC
group election is in effect, the CFC group election terminates solely
with respect to the applicable CFC.
(5) Manner of making or revoking a CFC group election--(i) In
general. An election is made or revoked under this paragraph (e)(5) (a
CFC group election) with respect to a specified period of a specified
group. A CFC group election remains in effect for each specified period
of the specified group until revoked. A CFC group election that is in
effect with respect to a specified period of a specified group applies
to each specified group member for its specified taxable year that ends
with or within the specified period. The making or revoking of a CFC
group election is not effective unless made or revoked by each
designated U.S. person.
(ii) Revocation by election. A CFC group election cannot be revoked
with respect to any specified period beginning prior to 60 months
following the last day of the specified period for which the election
was made. Once a CFC group election has been revoked, a new CFC group
election cannot be made with respect to any specified period beginning
prior to 60 months following the last day of the specified period for
which the election was revoked.
(iii) Timing. A CFC group election must be made or revoked with
respect to a specified period of a specified group no later than the
due date (taking into account extensions, if any) of the original
Federal income tax return for the taxable year of each designated U.S.
person in which or with which the specified period ends.
(iv) Election statement. Except as otherwise provided in
publications, forms, instructions, or other guidance, to make or revoke
a CFC group election for a specified period of a specified group, each
designated U.S. person must attach a statement to its relevant Federal
tax or information return. The statement must include the name and
taxpayer identification number of all designated U.S. persons, a
statement that the CFC group election is being made or revoked, as
applicable, the specified period for which the CFC group election is
being made or revoked,
[[Page 56910]]
and the name of each CFC group member and its specified taxable year
with respect to the specified period. The statement must be filed in
the manner prescribed in publications, forms, instructions, or other
guidance.
(v) Effect of prior CFC group election. A CFC group election is
made solely pursuant to the provisions of this paragraph (e)(5),
without regard to whether the election described in proposed Sec.
1.163(j)-7(f)(7) that was included in a notice of proposed rulemaking
(REG-106089-18) that was published on December 28, 2018, in the Federal
Register (83 FR 67490) was in effect.
(f) Treatment of a CFC group member that has ECI--(1) In general.
If a CFC group member has ECI in its specified taxable year, then for
purposes of section 163(j) and the section 163(j) regulations--
(i) The items, disallowed business interest expense carryforwards,
and other attributes of the CFC group member that are ECI are treated
as items, disallowed business interest expense carryforwards, and
attributes of a separate applicable CFC (such deemed corporation, an
ECI deemed corporation), subject to Sec. 1.163(j)-8(d), that has same
taxable year and shareholders as the applicable CFC; and
(ii) The ECI deemed corporation is not treated as a specified group
member for the specified taxable year.
(2) Ordering rule. Paragraph (f)(1) of this section applies before
application of Sec. 1.163(j)-8(d).
(g) * * *
(3) Treatment of certain taxes. For purposes of computing the ATI
of a relevant foreign corporation for a taxable year, tentative taxable
income takes into account any deduction for foreign taxes. See section
164(a).
(4) Anti-abuse rule--(i) In general. If a specified group member of
a specified group or an applicable partnership (specified lender)
includes an amount (the payment amount) in income and such amount is
attributable to business interest expense incurred by another specified
group member or an applicable partnership of the specified group (a
specified borrower) during its taxable year, then the ATI of the
specified borrower for the taxable year is increased by the ATI
adjustment amount if--
(A) The business interest expense is incurred with a principal
purpose of reducing the Federal income tax liability of any United
States shareholder of a specified group member (including over multiple
taxable years);
(B) Absent the application of this paragraph (g)(4), the effect of
the specified borrower treating all or part of the payment amount as
disallowed business interest expense would be to reduce the Federal
income tax liability of any United States shareholder of a specified
group member; and
(C) Either no CFC group election is in effect with respect to the
specified group or the specified borrower is an applicable partnership.
(ii) ATI adjustment amount--(A) In general. For purposes of this
paragraph (g)(4), the term ATI adjustment amount means, with respect to
a specified borrower and a taxable year, the product of 3\1/3\ and the
lesser of the payment amount or the disallowed business interest
expense, computed without regard to this paragraph (g)(4).
(B) Special rule for taxable years or specified periods beginning
in 2019 or 2020. For any taxable year of an applicable CFC or specified
taxable year of a CFC group member with respect to a specified period
for which the section 163(j) limitation is determined based, in part,
on 50 percent of ATI, in accordance with Sec. 1.163(j)-2(b)(2),
paragraph (g)(4)(ii)(A) of this section is applied by substituting
``2'' for ``3\1/3\.''
(iii) Applicable partnership. For purposes of this paragraph
(g)(4), the term applicable partnership means, with respect to a
specified group, a partnership in which at least 80 percent of the
interests in capital or profits is owned, directly or indirectly
through one or more other partnerships, by specified group members of
the specified group.
(h) Election to apply safe-harbor--(1) In general. If an election
to apply this paragraph (h)(1) (safe-harbor election) is in effect with
respect to a taxable year of a stand-alone applicable CFC or a
specified taxable year of a CFC group member, as applicable, then, for
such year, no portion of the applicable CFC's business interest expense
is disallowed under the section 163(j) limitation. This paragraph (h)
does not apply to excess business interest expense, as described in
Sec. 1.163(j)-6(f)(2), until the taxable year in which it is treated
as paid or accrued by an applicable CFC under Sec. 1.163(j)-
6(g)(2)(i). Furthermore, excess business interest expense is not taken
into account for purposes of determining whether the safe-harbor
election is available for a stand-alone applicable CFC or a CFC group
until the taxable year in which it is treated as paid or accrued by an
applicable CFC under Sec. 1.163(j)-6(g)(2)(i).
(2) Eligibility for safe-harbor election--(i) Stand-alone
applicable CFC. The safe-harbor election may be made for the taxable
year of a stand-alone applicable CFC only if business interest expense
of the applicable CFC is less than or equal to 30 percent of the lesser
of qualified tentative taxable income or the eligible amount of the
applicable CFC for its taxable year.
(ii) CFC group--(A) In general. The safe-harbor election may be
made for the specified period of a CFC group only if the business
interest expense of the CFC group for the specified period is less than
or equal to 30 percent of the lesser of the sum of qualified tentative
taxable income or the sum of the eligible amounts of each CFC group
member for its specified taxable year with respect to the specified
period, and no CFC group member has pre-group disallowed business
interest expense carryforward.
(B) Currency translation. For purposes of applying paragraph
(h)(2)(ii) of this section, qualified tentative taxable income and
eligible amounts of each CFC group member are translated into the
currency in which the business interest expense of the CFC group is
denominated using the method used under paragraph (c)(4) of this
section. See paragraph (c)(2)(i) of this section for rules for
determining the business interest expense of a CFC group.
(3) Eligible amount--(i) In general. Subject to paragraph
(h)(3)(ii) of this section, the term eligible amount means, with
respect to the taxable year of an applicable CFC, the sum of the
following amounts, computed without regard to the application of
section 163(j) and the section 163(j) regulations (including without
regard to any disallowed business interest expense carryforwards)--
(A) Subpart F income (within the meaning of section 952);
(B) The product of--
(1) The excess of 100 percent over the percentage described in
section 250(a)(1)(B), taking into account section 250(a)(3)(B), and
(2) The excess, if any, of tested income (within the meaning of
section 951A(c)(2)(A) and Sec. 1.951A-2(b)(1)), over the CFC-level net
deemed tangible income return.
(ii) Amounts properly allocable to a non-excepted trade or
business. For purposes of computing an eligible amount, subpart F
income and tested income are determined by only taking into account
items properly allocable to a non-excepted trade or business.
(4) Qualified tentative taxable income. The term qualified
tentative taxable income means, with respect to a taxable year of an
applicable CFC, the applicable CFC's tentative taxable income,
determined by only taking into
[[Page 56911]]
account items properly allocable to a non-excepted trade or business.
(5) Manner of making a safe-harbor election--(i) In general. A
safe-harbor election is an annual election made under this paragraph
(h)(5) with respect to a taxable year of a stand-alone applicable CFC
or with respect to a specified period of a CFC group. A safe-harbor
election that is made with respect to a specified period of a CFC group
is effective with respect to each CFC group member for its specified
taxable year. A safe-harbor election is only effective if made by each
designated U.S. person with respect to a stand-alone applicable CFC or
a CFC group. A safe-harbor election is made with respect to a taxable
year of a stand-alone applicable CFC, or a specified period of a CFC
group, no later than the due date (taking into account extensions, if
any) of the original Federal income tax return for the taxable year of
each designated U.S. person, respectively, in which or with which the
taxable year of the stand-alone applicable CFC ends or the specified
period of the CFC group ends.
(ii) Election statement. Unless otherwise provided in publications,
forms, instructions, or other guidance, to make a safe-harbor election,
each designated U.S. person must attach to its relevant Federal income
tax return or information return a statement that includes the name and
taxpayer identification number of all designated U.S. persons, a
statement that a safe-harbor election is being made pursuant to Sec.
1.163(j)-7(h) and that the requirements for making the election are
satisfied, and the taxable year of the stand-alone applicable CFC or
the specified period of the CFC group, as applicable, for which the
safe-harbor election is being made. In the case of a CFC group, the
statement must also include the name of each CFC group member and its
specified taxable year that ends with or within the specified period
for which the safe-harbor election is being made. The statement must be
filed in the manner prescribed in publications, forms, instructions, or
other guidance.
(6) Special rule for taxable years or specified periods beginning
in 2019 or 2020. In the case of a stand-alone applicable CFC, for any
taxable year beginning in 2019 or 2020, paragraph (h)(2)(i) of this
section is applied by substituting ``50 percent'' for ``30 percent.''
In the case of a CFC group, for any specified period beginning in 2019
or 2020, paragraph (h)(2)(ii)(A) of this section is applied by
substituting ``50 percent'' for ``30 percent.''
* * * * *
(j) Rules regarding the computation of ATI of certain United States
shareholders of applicable CFCs--(1) In general. For purposes of
computing ATI of a United States shareholder of an applicable CFC, for
the taxable year of the United States shareholder in which or with
which the taxable year of the applicable CFC ends, there is added to
the United States shareholder's tentative taxable income the product
of--
(i) The portion of the adjustment, if any, made to the United
States shareholder's tentative taxable income under Sec. 1.163(j)-
1(b)(1)(ii)(G) (regarding specified deemed inclusions) that is
attributable to the applicable CFC, but for this purpose excluding the
portion of the adjustment that is attributable to an inclusion under
section 78 with respect to the applicable CFC; and
(ii) A fraction, expressed as a percentage, but not greater than
100 percent, the numerator of which is CFC excess taxable income and
the denominator of which is the ATI of the applicable CFC for the
taxable year.
(2) Rules for determining CFC excess taxable income--(i) In
general. The term CFC excess taxable income means, with respect to a
taxable year of an applicable CFC, the amount described in paragraph
(j)(2)(ii) or (j)(2)(iii) of this section, as applicable.
(ii) Applicable CFC is a stand-alone applicable CFC. If an
applicable CFC is a stand-alone applicable CFC for a taxable year, its
CFC excess taxable income for the taxable year is the amount that bears
the same ratio to the applicable CFC's ATI as--
(A) The excess (if any) of--
(1) 30 percent of the applicable CFC's ATI; over
(2) The amount (if any) by which the applicable CFC's business
interest expense exceeds its business interest income and floor plan
financing interest expense; bears to
(B) 30 percent of the applicable CFC's ATI.
(iii) Applicable CFC is a CFC group member. If an applicable CFC is
a CFC group member for a specified taxable year, its CFC excess taxable
income is equal to the product of the CFC group member's ATI percentage
and the amount that bears the same ratio to the CFC group's ATI for the
specified period as--
(A) The excess (if any) of--
(1) 30 percent of the CFC group's ATI; over
(2) The amount (if any) by which the CFC group's business interest
expense exceeds the CFC group's business interest income and floor plan
financing interest expense; bears to
(B) 30 percent of the CFC group's ATI.
(iv) ATI percentage. For purposes of this paragraph (j), the term
ATI percentage means, with respect to a specified taxable year of a CFC
group member and a specified period of the CFC group, a fraction
(expressed as a percentage), the numerator of which is the ATI of the
CFC group member for the specified taxable year, and the denominator of
which is the ATI of the CFC group for the specified period. If either
the numerator or denominator of the fraction is less than or equal to
zero, the ATI percentage is zero.
(3) Cases in which an addition to tentative taxable income is not
allowed. Paragraph (j)(1) of this section is not applicable for a
taxable year of a United States shareholder if, with respect to the
taxable year of the applicable CFC described in paragraph (j)(1) of
this section--
(i) A safe-harbor election (as described in paragraph (h) of this
section) is in effect; or
(ii) The applicable CFC is neither a stand-alone applicable CFC nor
a CFC group member.
(4) Special rule for taxable years or specified periods beginning
in 2019 or 2020. In the case of a stand-alone applicable CFC, for any
taxable year beginning in 2019 or 2020 to which the election described
in Sec. 1.163(j)-2(b)(2)(ii) does not apply, paragraph (j)(2)(ii) of
this section is applied by substituting ``50 percent'' for ``30
percent'' each place it appears. In the case of a CFC group member, for
any specified taxable year with respect to a specified period beginning
in 2019 or 2020 to which the election described in Sec. 1.163(j)-
2(b)(2)(ii) does not apply, paragraph (j)(2)(iii) of this section is
applied by substituting ``50 percent'' for ``30 percent'' each place it
appears.
(k) Definitions. The following definitions apply for purposes of
this section.
(1) Applicable partnership. The term applicable partnership has the
meaning provided in paragraph (g)(4)(iii) of this section.
(2) Applicable specified taxable year. The term applicable
specified taxable year has the meaning provided in paragraph
(c)(3)(iii) of this section.
(3) ATI adjustment amount. The term ATI adjustment amount has the
meaning provided in paragraph (g)(4)(ii) of this section.
(4) ATI percentage. The term ATI percentage has the meaning
provided in paragraph (j)(2)(iv) of this section.
[[Page 56912]]
(5) CFC excess taxable income. The term CFC excess taxable income
has the meaning provided in paragraph (j)(2)(i) of this section.
(6) CFC group. The term CFC group has the meaning provided in
paragraph (e)(2)(i) of this section.
(7) CFC group election. The term CFC group election means the
election described in paragraph (e)(5) of this section.
(8) CFC group member. The term CFC group member has the meaning
provided in paragraph (e)(2)(ii) of this section.
(9) CFC-level net deemed tangible income return--(i) In general.
The term CFC-level net deemed tangible income return means, with
respect to a taxable year of an applicable CFC, the excess (if any)
of--
(A) 10 percent of the qualified business asset investment, as
defined in section 951A(d)(1) and Sec. 1.951A-3(b), of the applicable
CFC, over
(B) The excess, if any, of--
(1) Tested interest expense, as defined in Sec. 1.951A-4(b)(1), of
the applicable CFC, over
(2) Tested interest income, as defined in Sec. 1.951A-4(b)(2), of
the applicable CFC.
(ii) Amounts properly allocable to a non-excepted trade or
business. For purposes of computing CFC-level net deemed tangible
income return, qualified business asset investment is determined by
only taking into account assets properly allocable to a non-excepted
trade or business, as determined in Sec. 1.163(j)-10(c)(3), and tested
interest expense and tested interest income are determined by only
taking into account items properly allocable to a non-excepted trade or
business, as determined in Sec. 1.163(j)-10(c).
(10) Cumulative section 163(j) pre-group carryforward limitation.
The term cumulative section 163(j) pre-group carryforward limitation
has the meaning provided in paragraph (c)(3)(iv)(A)(1) of this section.
(11) Current group. The term current group has the meaning provided
in paragraph (c)(3)(iv)(A)(2) of this section.
(12) Designated U.S. person. The term designated U.S. person
means--
(i) With respect to a stand-alone applicable CFC, each controlling
domestic shareholder, as defined in Sec. 1.964-1(c)(5) of the
applicable CFC; or
(ii) With respect to a specified group, the specified group parent,
if the specified group parent is a qualified U.S. person, or each
controlling domestic shareholder, as defined in Sec. 1.964-1(c)(5), of
the specified group parent, if the specified group parent is an
applicable CFC.
(13) ECI deemed corporation. The term ECI deemed corporation has
the meaning provided in paragraph (f)(1)(i) of this section.
(14) Effectively connected income. The term effectively connected
income (or ECI) means income or gain that is ECI, as defined in Sec.
1.884-1(d)(1)(iii), and deduction or loss that is allocable to, ECI, as
defined in Sec. 1.884-1(d)(1)(iii).
(15) Eligible amount. The term eligible amount has the meaning
provided in paragraph (h)(3)(i) of this section.
(16) Former group. The term former group has the meaning provided
in paragraph (c)(3)(iv)(A)(2) of this section.
(17) Loss member. The term loss member has the meaning provided in
paragraph (c)(3)(iv)(A)(2) of this section.
(18) Payment amount. The term payment amount has the meaning
provided in paragraph (g)(4)(i) of this section.
(19) Pre-group disallowed business interest expense carryforward.
The term pre-group disallowed business interest expense carryforward
means, with respect to a CFC group member and a specified taxable year,
any disallowed business interest expense carryforward of the CFC group
member that arose in a taxable year during which the CFC group member
(or its predecessor) was not a CFC group member of the CFC group.
(20) Qualified tentative taxable income. The term qualified
tentative taxable income has the meaning provided in paragraph (h)(4)
of this section.
(21) Qualified U.S. person. The term qualified U.S. person has the
meaning provided in paragraph (d)(2)(iv) of this section.
(22) Relevant period. The term relevant period has the meaning
provided in paragraph (c)(3)(iv)(A)(2) of this section.
(23) Safe-harbor election. The term safe-harbor election has the
meaning provided in paragraph (h)(1) of this section.
(24) Specified borrower. The term specified borrower has the
meaning provided in paragraph (g)(4)(i) of this section.
(25) Specified group. The term specified group has the meaning
provided in paragraph (d)(2)(i) of this section.
(26) Specified group member. The term specified group member has
the meaning provided in paragraph (d)(3) of this section.
(27) Specified group parent. The term specified group parent has
the meaning provided in paragraph (d)(2)(iii) of this section.
(28) Specified lender. The term specified lender has the meaning
provided in paragraph (g)(4)(i) of this section
(29) Specified period--(i) In general. Except as otherwise provided
in paragraph (k)(29)(ii) of this section, the term specified period
means, with respect to a specified group--
(A) If the specified group parent is a qualified U.S. person, the
period ending on the last day of the taxable year of the specified
group parent and beginning on the first day after the last day of the
specified group's immediately preceding specified period; or
(B) If the specified group parent is an applicable CFC, the period
ending on the last day of the specified group parent's required year
described in section 898(c)(1), without regard to section 898(c)(2),
and beginning on the first day after the last day of the specified
group's immediately preceding specified period.
(ii) Short specified period. A specified period begins no earlier
than the first date on which a specified group exists. A specified
period ends on the date a specified group ceases to exist under
paragraph (d)(2)(vii) of this section. If the last day of a specified
period, as determined under paragraph (k)(29)(i) of this section,
changes, and, but for this paragraph (k)(29)(ii), the change in the
last day of the specified period would result in the specified period
being longer than 12 months, the specified period ends on the date on
which the specified period would have ended had the change not
occurred.
(30) Specified taxable year. The term specified taxable year means,
with respect to an applicable CFC that is a specified group member of a
specified group and a specified period, a taxable year of the
applicable CFC that ends with or within the specified period.
(31) Stand-alone applicable CFC. The term stand-alone applicable
CFC means any applicable CFC that is not a specified group member.
(32) Stock. The term stock has the meaning provided in paragraph
(d)(2)(v) of this section.
(l) Examples. The following examples illustrate the application of
this section. For each example, unless otherwise stated, no exemptions
from the application of section 163(j) are available, no foreign
corporation has ECI, and all relevant taxable years and specified
periods begin after December 31, 2020.
(1) Example 1. Specified taxable years included in specified
period of a specified
[[Page 56913]]
group--(i) Facts. As of June 30, Year 1, USP, a domestic
corporation, owns 60 percent of the common stock of FP, which owns
all of the stock of FC1, FC2, and FC3. The remaining 40 percent of
the common stock of FP is owned by an unrelated foreign corporation.
FP has a single class of stock. FP acquired the stock of FC3 from an
unrelated person on March 22, Year 1. The acquisition did not result
in a change in FC3's taxable year or a close of its taxable year.
USP's interest in FP and FP's interest in FC1 and FC2 has been the
same for a number of years. USP has a taxable year ending June 30,
Year 1, which is not a short taxable year. Each of FP, FC1, FC2, and
FC3 are applicable CFCs. Pursuant to section 898(c)(2), FP and FC1
have taxable years ending May 31, Year 1. Pursuant to section
898(c)(1), FC2 and FC3 have taxable years ending June 30, Year 1.
(ii) Analysis--(A) Determining a specified group and specified
period of the specified group. Pursuant to paragraph (d) of this
section, FP, FC1, FC2, and FC3 are members of a specified group, and
FP is the specified group parent. Because the specified group
parent, FP, is an applicable CFC, the specified period of the
specified group is the period ending on June 30, Year 1, which is
the last day of FP's required year described in section 898(c)(1),
without regard to section 898(c)(2), and on beginning July 1, Year
0, which is the first day following the last day of the specified
group's immediately preceding specified period (June 30, Year 0).
See paragraph (k)(29)(i)(B) of this section.
(B) Determining the specified taxable years with respect to the
specified period. Pursuant to paragraph (d)(3) of this section,
because each of FP and FC1 are included in the specified group on
the last day of their taxable years ending May 31, Year 1 and such
taxable years end with or within the specified period ending June
30, Year 1, FP and FC1 are specified group members with respect to
the specified period ending June 30, Year 1, for their entire
taxable years ending May 31, Year 1, and those taxable years are
specified taxable years. Similarly, because each of FC2 and FC3 are
included in the specified group on the last day of their taxable
years ending June 30, Year 1, and such taxable years end with or
within the specified period ending June 30, Year 1, FC2 and FC3 are
specified group members with respect to the specified period ending
June 30, Year 1, for their entire taxable years ending June 30, Year
1, and those taxable years are specified taxable years. The fact
that FC3 was acquired on March 22, Year 1, does not prevent FC3 from
being a specified group member with respect to the specified period
for the portion of its specified taxable year prior to March 22,
Year 1.
(2) Example 2. CFC groups--(i) Facts. The facts are the same as
in Example 1 in paragraph (l)(1)(i) of this section. In addition, a
CFC group election is in place with respect to the specified period
ending June 30, Year 1.
(ii) Analysis. Because a CFC group election is in place for the
specified period ending June 30, Year 1, pursuant to paragraph
(e)(2)(ii) of this section, each specified group member is a CFC
group member with respect to its specified taxable year ending with
or within the specified period. Accordingly, FP, FC1, FC2, and FC3
are CFC group members with respect to the specified period ending
June 30, Year 1, for their specified taxable years ending May 31,
Year 1, and June 30, Year 1, respectively. Pursuant to paragraph
(e)(2)(i) of this section, the CFC group for the specified period
ending June 30, Year 1, consists of FP, FC1, FC2, and FC3 for their
specified taxable years ending May 31, Year 1, and June 30, Year 1,
respectively. Pursuant to paragraph (c)(2) of this section, a single
section 163(j) limitation is computed for the specified period
ending June 30, Year 1. That section 163(j) calculation will include
FP and FC1's specified taxable years ending May 31, Year 1, and FC2
and FC3's specified taxable years ending June 30, Year 1.
(3) Example 3. Application of anti-abuse rule--(i) Facts. USP, a
domestic corporation, is the specified group parent of a specified
group. The specified group members include CFC1 and CFC2. USP owns
(within the meaning of section 958(a)) all of the stock of all
specified group members. USP has a calendar year taxable year. All
specified group members also have a calendar year taxable year and a
functional currency of the U.S. dollar. CFC1 is organized in, and a
tax resident of, a jurisdiction that imposes no tax on certain types
of income, including interest income. With respect to Year 1, USP
expects to pay no residual U.S. tax on its income inclusion under
section 951A(a) (GILTI inclusion) and expects to have unused foreign
tax credits in the category described in section 904(d)(1)(A). A CFC
group election is not in effect for Year 1. With a principal purpose
of reducing USP's Federal income tax liability, on January 1, Year
1, CFC1 loans $100x to CFC2. On December 31, Year 1, CFC2 pays
interest of $10x to CFC1 and repays the principal of $100x. Absent
application of paragraph (g)(4)(i) of this section, CFC2 would treat
all $10x of interest expense as disallowed business interest expense
and therefore would have $10x of disallowed business interest
expense carryforward to Year 2. In Year 2, CFC2 disposes of one of
its businesses at a substantial gain that gives rise to tested
income (within the meaning of section 951A(c)(2)(A) and Sec.
1.951A-2(b)(1)). Assume that as a result of the gain being included
in the ATI of CFC2, absent application of paragraph (g)(3)(i) of
this section, CFC2 would be allowed to deduct the entire $10x of
disallowed business interest expense carryforward and therefore
reduce the amount of CFC2's tested income. Also, assume that USP
would have residual U.S. tax on its GILTI inclusion in Year 2,
without regard to the application of paragraph (g)(4)(i) of this
section.
(ii) Analysis. The $10x of interest expense paid in Year 1 is a
payment amount described in paragraph (g)(4)(i) of this section
because it is between specified group members, CFC1 and CFC2.
Furthermore the requirements of paragraph (g)(4)(i)(A), (B), and (C)
of this section are satisfied because the business interest expense
is incurred with a principal purpose of reducing USP's Federal
income tax liability; absent the application of paragraph (g)(4)(i)
of this section, the effect of CFC2 treating the $10x of business
interest expense as disallowed business interest expense in Year 1
would be to reduce USP's Federal income tax liability in Year 2; and
no CFC group election is in effect with respect to the specified
group in Year 1. Because the requirements of paragraph (g)(4)(i)(A),
(B), and (C) of this section are satisfied, CFC2's ATI for Year 1 is
increased by $33.33x, which is the amount equal to 3 \1/3\
multiplied by $10x (the lesser of the payment amount of $10x and the
disallowed business interest expense of $10x). As a result, the $10x
of business interest expense is not treated by CFC2 as disallowed
business interest expense in Year 1, and therefore does not give
rise to a disallowed business interest expense carryforward to Year
2.
(m) Applicability dates--(1) General applicability date. Except as
provided in paragraph (m)(2) of this section, this section applies to
taxable years of a foreign corporation beginning on or after November
13, 2020 However, except as provided in paragraph (m)(2) of this
section, taxpayers and their related parties, within the meaning of
sections 267(b) and 707(b)(1), may choose to apply the rules of this
section to a taxable year beginning after December 31, 2017, so long as
the taxpayers and their related parties consistently apply the rules of
this section to each subsequent taxable year and the section 163(j)
regulations, and if applicable, Sec. Sec. 1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0,
1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1,
1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through
1.1502-99 (to the extent they effectuate the rules of Sec. Sec. 1.382-
2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4 to that taxable year
and each subsequent taxable year.
(2) Exception. Paragraphs (a), (c) through (f), (g)(3) and (4), and
(h) through (k) of this section apply to taxable years beginning on or
after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE
FEDERAL REGISTER]. However, taxpayers and their related parties, within
the meaning of sections 267(b) and 707(b)(1), may choose to apply
paragraphs (a), (c) through (f), (g)(3) and (4), and (h) through (k) of
this section in their entirety for a taxable year beginning after
December 31, 2017, so long as the taxpayers and their related parties
also apply Sec. 1.163(j)-8 for the taxable year. For taxable years
beginning before November 13, 2020, taxpayers and their related parties
may not choose to apply paragraphs (a), (c) through (f), (g)(3) and
(4), and (h) through (k) of this section unless they also apply
paragraphs (b) and (g)(1) and (2) of this section in accordance with
[[Page 56914]]
the second sentence of paragraph (m)(1) of this section.
Notwithstanding paragraph (e)(5)(iii) or (h)(5)(i) of this section, in
the case of a specified period of a specified group or a taxable year
of a stand-alone applicable CFC that ends with or within a taxable year
of a designated U.S. person ending before November 13, 2020, a CFC
group election or a safe-harbor election may be made on an amended
Federal income tax return filed on or before the due date (taking into
account extensions, if any) of the original Federal income tax return
for the first taxable year of each designated U.S. person ending after
November 13, 2020.
0
Par. 9. As reserved in a final rule elsewhere in this issue of the
Federal Register, effective November 13, 2020, Sec. 1.163(j)-8 is
added to read as follows:
Sec. 1.163(j)-8 Application of the section 163(j) limitation to
foreign persons with effectively connected income.
(a) Overview. This section provides rules concerning the
application of section 163(j) to foreign persons with ECI. Paragraph
(b) of this section modifies the application of section 163(j) for a
specified foreign person with ECI. Paragraph (c) of this section sets
forth rules for a specified foreign partner in a partnership with ECI.
Paragraph (d) of this section allocates disallowed business interest
expense for relevant foreign corporations with ECI. Paragraph (e) of
this section provides rules concerning disallowed business interest
expense. Paragraph (f) of this section coordinates the application of
section 163(j) with Sec. 1.882-5 and the branch profits tax under
section 884. Paragraph (g) of this section provides definitions that
apply for purposes of this section. Paragraph (h) of this section
illustrates the application of this section through examples.
(b) Application to a specified foreign person with ECI--(1) In
general. If a taxpayer is a specified foreign person, then the taxpayer
applies the modifications described in this paragraph (b), taking into
account the application of paragraph (c) of this section.
(2) Modification of adjusted taxable income. Adjusted taxable
income for a specified foreign person for a taxable year means the
specified foreign person's adjusted taxable income, as determined under
Sec. 1.163(j)-1(b)(1), taking into account only items that are ECI.
(3) Modification of business interest expense. Business interest
expense for a specified foreign person means business interest expense
described in Sec. 1.163(j)-1(b)(3) that is ECI, taking into account
the application of paragraph (f)(1)(iii) of this section.
(4) Modification of business interest income. The business interest
income of a specified foreign person means business interest income
described in Sec. 1.163(j)-1(b)(4) that is ECI.
(5) Modification of floor plan financing interest expense. The
floor plan financing interest expense of a specified foreign person
means floor plan financing interest expense described Sec. 1.163(j)-
1(b)(19) that is ECI.
(6) Modification of allocation of interest expense and interest
income that is allocable to a trade or business. For purposes of
applying Sec. 1.163(j)-10(c) to a specified foreign person, only
interest income and interest expense that are ECI and only assets that
are U.S. assets, as defined in Sec. 1.884-1(d), are taken into
account. If the specified foreign person is also a specified foreign
partner, this paragraph (b)(6) does not apply to any trade or business
of the partnership.
(c) Rules for a specified foreign partner--(1) Characterization of
excess taxable income--(i) In general. The portion of excess taxable
income allocated to a specified foreign partner from a partnership
pursuant to Sec. 1.163(j)-6(f)(2) that is ECI is equal to the
specified foreign partner's allocation of excess taxable income from
the partnership multiplied by its specified ATI ratio with respect to
the partnership, and the remainder is not ECI.
(ii) Specified ATI ratio. The term specified ATI ratio means the
fraction described in this paragraph (c)(1)(ii). If the specified
foreign partner's distributive share of ECI and distributive share of
non-ECI are both positive, the numerator of this fraction is the
specified foreign partner's distributive share of ECI and the
denominator is the specified foreign partner's distributive share of
partnership items of income, gain, deduction, and loss. If the
specified foreign partner's distributive share of ECI is negative or
zero and its distributive share of non-ECI is positive, this fraction
is treated as zero. If the specified foreign partner's distributive
share of non-ECI is negative or zero and its distributive share of ECI
is positive, this fraction is treated as one. If the specified foreign
partner's distributive share of ECI and distributive share of non-ECI
are both negative, the numerator of this fraction is its distributive
share of non-ECI and the denominator is its distributive share of
partnership items of income, gain, deduction, and loss.
(iii) Distributive share of ECI. The term distributive share of ECI
means the net amount of the specified foreign partner's distributive
share of partnership items of income, gain, deduction, and loss that
are ECI.
(iv) Distributive share of non-ECI. The term distributive share of
non-ECI means the net amount of the specified foreign partner's
distributive share of partnership items of income, gain, deduction, and
loss that are not ECI.
(2) Characterization of excess business interest expense--(i)
Allocable ECI excess BIE. The portion of excess business interest
expense allocated to a specified foreign partner from a partnership
pursuant to Sec. 1.163(j)-6(f)(2) or paragraph (e)(2) of this section
that is ECI (allocable ECI excess BIE) is equal to the excess, if any,
of allocable ECI BIE over allocable ECI deductible BIE.
(ii) Allocable non-ECI excess BIE. The portion of excess business
interest expense allocated to a specified foreign partner from a
partnership pursuant to Sec. 1.163(j)-6(f)(2) or paragraph (e)(2) of
this section that is not ECI (allocable non-ECI excess BIE) is equal to
the excess, if any, of allocable non-ECI BIE over allocable non-ECI
deductible BIE.
(3) Characterization of deductible business interest expense--(i)
In general. The portion of deductible business interest expense, if
any, that is allocated to a specified foreign partner from a
partnership pursuant to Sec. 1.163(j)-6(f)(2) that is ECI (allocable
ECI deductible BIE) is equal to the sum of the amounts described in
paragraphs (c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of this section.
The portion of deductible business interest expense, if any, that is
allocated to a specified foreign partner from a partnership pursuant to
Sec. 1.163(j)-6(f)(2) that is not ECI (allocable non-ECI deductible
BIE) is equal to the sum of the amounts described in paragraphs
(c)(3)(ii)(A)(1)(ii) and (c)(3)(ii)(B)(2) of this section.
(ii) Allocation between allocable ECI deductible BIE and allocable
non-ECI deductible BIE. For purposes of paragraph (c)(3)(i) of this
section--
(A) Allocation to hypothetical deductible amounts--(1) In general.
Subject to paragraph (c)(3)(ii)(A)(2) of this section, deductible
business interest expense that is allocated to the specified foreign
partner from the partnership pursuant to Sec. 1.163(j)-6(f)(2) is
allocated pro rata to--
(i) Hypothetical partnership ECI deductible BIE; and
(ii) Hypothetical partnership non-ECI deductible BIE.
(2) Limitation. The amount allocated to hypothetical partnership
ECI
[[Page 56915]]
deductible BIE in paragraph (c)(3)(ii)(A)(1)(i) of this section cannot
exceed the lesser of hypothetical partnership ECI deductible BIE or
allocable ECI BIE, and the amount allocated to hypothetical partnership
non-ECI deductible BIE in paragraph (c)(3)(ii)(A)(1)(ii) of this
section cannot exceed the lesser of hypothetical partnership non-ECI
deductible BIE or allocable non-ECI BIE.
(B) Allocation of remaining deductible amounts. Deductible business
interest expense that is allocated to the specified foreign partner
from the partnership pursuant to Sec. 1.163(j)-6(f)(2) in excess of
the amount allocated in paragraph (c)(3)(ii)(A) of this section, if
any, is allocated pro rata to--
(1) Allocable ECI BIE, reduced by the amount described in paragraph
(c)(3)(ii)(A)(1)(i) of this section; and
(2) Allocable non-ECI BIE, reduced by the amount described in
paragraph (c)(3)(ii)(A)(1)(ii) of this section.
(iii) Hypothetical partnership deductible business interest
expense--(A) Hypothetical partnership ECI deductible BIE. The term
hypothetical partnership ECI deductible BIE means the deductible
business interest expense of the partnership, as defined in Sec.
1.163(j)-6(b)(5), determined by only taking into account the specified
foreign partner's allocable share of items that are ECI (including by
reason of paragraph (f)(1)(iii) of this section).
(B) Hypothetical partnership non-ECI deductible BIE. The term
hypothetical partnership non-ECI deductible BIE means the deductible
business interest expense of the partnership, as defined in Sec.
1.163(j)-6(b)(5), determined by only taking into account the specified
foreign partner's allocable share of items that are not ECI (including
by reason of paragraph (f)(1)(iii) of this section).
(4) Characterization of excess business interest income--(i) In
general. The portion of excess business interest income allocated to a
specified foreign partner from a partnership pursuant to Sec.
1.163(j)-6(f)(2) that is ECI is equal to the specified foreign
partner's allocation of excess business interest income from the
partnership multiplied by its specified BII ratio with respect to the
partnership, and the remainder is not ECI.
(ii) Specified BII ratio. The term specified BII ratio means the
ratio of the specified foreign partner's allocable ECI BII to allocable
business interest income (determined under Sec. 1.163(j)-6(f)(2)(ii)).
(iii) Allocable ECI BII. The term allocable ECI BII means the
specified foreign partner's allocable BII, as determined under Sec.
1.163(j)-6(f)(2)(ii), computed by only taking into account income that
is ECI.
(5) Rules for determining ECI. Except as described in paragraph
(f)(1) of this section, if the determination as to whether partnership
items are ECI is made by a direct or indirect partner, rather than the
partnership itself, then for purposes of this paragraph (c), the
partnership must use a reasonable method to characterize such items as
ECI or as not ECI.
(d) Characterization of disallowed business interest expense by a
relevant foreign corporation with ECI--(1) Scope. A relevant foreign
corporation that has ECI and disallowed business interest expense for a
taxable year determines the portion of its disallowed business interest
expense and deductible business interest expense that is characterized
as ECI or as not ECI under this paragraph (d). A relevant foreign
corporation that is a specified foreign partner also applies the rules
in paragraph (c) of this section. See also Sec. 1.163(j)-7(f) for
rules regarding CFC group members with ECI.
(2) Characterization of disallowed business interest expense--(i)
FC ECI disallowed BIE. For purposes of this section, the portion of
disallowed business interest expense of a relevant foreign corporation
that is ECI (FC ECI disallowed BIE) is equal to the excess, if any, of
FC ECI BIE over FC ECI deductible BIE.
(ii) FC non-ECI disallowed BIE. For purposes of this section, the
portion of disallowed business interest expense of a relevant foreign
corporation that is not ECI (FC non-ECI disallowed BIE) is equal to the
excess, if any, of FC non-ECI BIE over FC non-ECI deductible BIE.
(3) Characterization of deductible business interest expense--(i)
In general. The portion of deductible business interest expense, if
any, that is ECI (FC ECI deductible BIE) is equal to the sum of the
amounts described in paragraphs (d)(3)(ii)(A)(1)(i) and
(d)(3)(ii)(B)(1) of this section. The portion of deductible business
interest expense, if any, that is allocable to income that is not ECI
(FC non-ECI deductible BIE) is equal to the sum of the amounts
described in paragraphs (d)(3)(ii)(A)(1)(ii) and (d)(3)(ii)(B)(2) of
this section.
(ii) Allocation between FC ECI deductible BIE and FC non-ECI
deductible BIE. For purposes of paragraph (d)(3)(i) of this section--
(A) Allocation to hypothetical deductible amounts--(1) In general.
Subject to paragraph (d)(3)(ii)(A)(2) of this section, deductible
business interest expense is allocated pro rata to--
(i) Hypothetical FC ECI deductible BIE; and
(ii) Hypothetical FC non-ECI deductible BIE.
(2) Limitation. The amount allocated to hypothetical FC ECI
deductible BIE in paragraph (d)(3)(ii)(A)(1)(i) of this section cannot
exceed the lesser of hypothetical FC ECI deductible BIE or FC ECI BIE,
and the amount allocated to hypothetical FC non-ECI deductible BIE in
paragraph (d)(3)(ii)(A)(1)(ii) of this section cannot exceed the lesser
of hypothetical FC non-ECI deductible BIE or FC non-ECI BIE.
(B) Allocation of remaining deductible amounts. Deductible business
interest expense in excess of the amount allocated in paragraph
(d)(3)(ii)(A) of this section, if any, is allocated pro rata to--
(1) FC ECI BIE, reduced by the amount described in paragraph
(d)(3)(ii)(A)(1)(i) of this section; and
(2) FC non-ECI BIE, reduced by the amount described in paragraph
(d)(3)(ii)(A)(1)(ii) of this section.
(iii) Hypothetical FC deductible business interest expense--(A)
Hypothetical FC ECI deductible BIE. The term hypothetical FC ECI
deductible BIE means the deductible business interest expense of the
relevant foreign corporation determined by only taking into account its
items that are ECI.
(B) Hypothetical FC non-ECI deductible BIE. The term hypothetical
FC non-ECI deductible BIE means the deductible business interest
expense of the relevant foreign corporation determined by only taking
into account its items that are not ECI.
(e) Rules regarding disallowed business interest expense--(1)
Retention of character in a succeeding taxable year. Disallowed
business interest expense of a specified foreign person or a relevant
foreign corporation for a taxable year (including excess business
interest expense allocated to a specified foreign partner under Sec.
1.163(j)-6(f)(2) or paragraph (e)(2) of this section) that is ECI or is
not ECI retains its character as ECI or as not ECI in a succeeding
taxable year.
(2) Deemed allocation of excess business interest expense of a
partnership to a specified foreign partner. For purposes of this
paragraph (e) and paragraphs (c)(2), (g)(3), and (g)(7) of this
section, a specified foreign partner's allocable share of business
interest expense is deemed to include its allocable share of excess
business interest expense of a partnership in which it is a direct or
indirect partner. For purposes of this paragraph (e)(2), a specified
foreign partner's allocable share of excess business interest
[[Page 56916]]
expense of a partnership in which it is a direct or indirect partner is
determined as if the excess business interest expense of the
partnership were deductible in the taxable year in which the interest
expense is first paid or accrued.
(3) Ordering rule for conversion of excess business interest
expense to business interest expense paid or accrued by a partner. A
specified foreign partner's allocable share of excess business interest
expense (determined under Sec. 1.163(j)-6(f)(2) or paragraph (e)(2) of
this section) is treated as business interest expense paid or accrued
under Sec. 1.163(j)-6(g)(2)(i) in the order of the taxable years in
which the excess business interest expense arose, and pro rata between
allocable ECI excess BIE and allocable non-ECI excess BIE that arose in
the same taxable year. This paragraph (e)(3) applies before application
of paragraph (b)(3) of this section.
(4) Allocable ECI excess BIE and allocable non-ECI excess BIE
retains its character when treated as business interest expense paid or
accrued in a succeeding taxable year. If excess business interest
expense of a partnership in which a specified foreign partner is a
direct or indirect partner is treated as business interest expense paid
or accrued by the specified foreign partner or a partnership in which
it is a direct or indirect partner under Sec. 1.163(j)-6(g)(2)(i),
then allocable ECI excess BIE is treated as business interest expense
allocable to ECI and allocable non-ECI excess BIE is treated as
business interest expense allocable to income that is not ECI.
(f) Coordination of the application of section 163(j) with Sec.
1.882-5 and similar provisions and with the branch profits tax--(1)
Coordination of section 163(j) with Sec. 1.882-5 and similar
provisions--(i) Ordering rule. A foreign corporation first determines
its business interest expense allocable to ECI under Sec. 1.882-5 or
any other relevant provision (Sec. 1.882-5 and similar provisions)
before applying section 163(j) to the foreign corporation. If a foreign
corporation has a disallowed business interest expense carryforward
from a taxable year, then none of that business interest expense is
taken into account for purposes of determining business interest
expense under Sec. 1.882-5 and similar provisions in a succeeding
taxable year.
(ii) Treatment of excess business interest expense. For purposes of
applying Sec. 1.882-5 and similar provisions, the business interest
expense of a specified foreign partner that is a direct or indirect
partner in a partnership is determined without regard to the
application of section 163(j) to the partnership. As a result, for
purposes of applying Sec. 1.882-5 and similar provisions, the
specified foreign partner's share of business interest expense on
liabilities of a partnership in which it is a direct or indirect
partner is determined as if any excess business interest expense of the
partnership (determined under Sec. 1.163(j)-6(f)(2) or paragraph
(e)(2) of this section) were deductible in the taxable year in which
the business interest expense is first paid or accrued and not in a
succeeding taxable year.
(iii) Attribution of certain Sec. 1.882-5 interest expense among
the foreign corporation and its partnership interests--(A) In general.
If a foreign corporation is a specified foreign partner in one or more
partnerships, then, for purposes of section 163(j) and the section
163(j) regulations, interest expense determined under Sec. 1.882-5(b)
through (d) or Sec. 1.882-5(e) (Sec. 1.882-5 three-step interest
expense) is treated as attributable to liabilities of the foreign
corporation or the foreign corporation's share of liabilities of each
partnership in accordance with paragraphs (f)(1)(iii)(B) and
(f)(1)(iii)(C) of this section. Accordingly, the portion of the Sec.
1.882-5 three-step interest expense attributable to liabilities of the
foreign corporation described in this paragraph (f)(1)(iii) is subject
to section 163(j) and the section 163(j) regulations at the level of
the foreign corporation. The portion of the Sec. 1.882-5 three-step
interest expense interest attributable to liabilities of a partnership
described in this paragraph (f)(1)(iii) is subject to section 163(j)
and the section 163(j) regulations at the partnership-level. See Sec.
1.163(j)-6. This paragraph (f)(1)(iii) merely characterizes interest
expense of the foreign corporation and its partnership interests as ECI
or not ECI. It does not change the amount of interest expense of the
foreign corporation or its partnership interests.
(B) Attribution of interest expense on U.S. booked liabilities. The
Sec. 1.882-5 three-step interest expense is treated as attributable,
pro rata, to interest expense on U.S. booked liabilities of a foreign
corporation, determined under Sec. 1.882-5(d)(2)(ii)-(iii) or its
interest expense on its share of U.S. booked liabilities of a
partnership, determined under Sec. 1.882-5(d)(2)(vii), as applicable,
to the extent thereof (without regard to whether the foreign
corporation uses the method described in Sec. 1.882-5(b) through (d)
or the method described in Sec. 1.882-5(e) for purposes of determining
Sec. 1.882-5 interest expense).
(C) Attribution of excess Sec. 1.882-5 three-step interest
expense--(1) In general. The Sec. 1.882-5 three-step interest expense
in excess of interest expense attributable to U.S. booked liabilities
described in Sec. 1.882-5(d)(2), if any (excess Sec. 1.882-5 three-
step interest expense), is treated as attributable to liabilities of
the foreign corporation or the foreign corporation's allocable share of
liabilities of one or more partnerships, in accordance with paragraphs
(f)(1)(iii)(C)(2) and (f)(1)(iii)(C)(3) of this section, subject to the
limitation in paragraph (f)(1)(iii)(C)(4) of this section. For purposes
of this paragraph (f)(1)(iii)(C), the term ``U.S. assets'' means U.S.
assets described in Sec. 1.882-5(b).
(2) Attribution of excess Sec. 1.882-5 three-step interest expense
to the foreign corporation. Excess Sec. 1.882-5 three-step interest
expense is treated as attributable to interest expense on liabilities
of the foreign corporation (and not its partnership interests) in
proportion to its U.S. assets other than its partnership interests over
all of its U.S. assets.
(3) Attribution of excess Sec. 1.882-5 three-step interest expense
to partnerships--(i) In general. Excess Sec. 1.882-5 three-step
interest expense is treated as attributable to interest expense on the
foreign corporation's direct or indirect allocable share of liabilities
of a partnership in proportion to the portion of the partnership
interest that is treated as a U.S. asset under paragraph
(f)(1)(iii)(C)(3)(ii) of this section over all of the foreign
corporation's U.S. assets.
(ii) Direct and indirect partnership interests. If a foreign
corporation owns an interest in a partnership that does not own an
interest in any other partnerships, the portion of the partnership
interest that is a U.S. asset is determined under Sec. 1.882-5(b). If
a foreign corporation owns an interest in a partnership (the top-tier
partnership) that owns an interest in one or more other partnerships,
directly or indirectly (the lower-tier partnerships), the portion of
the foreign corporation's direct or indirect interest in the top-tier
partnership and lower-tier partnerships that is a U.S. asset is
determined by re-attributing the portion of the top-tier partnership
interest that is a U.S. asset, as determined under Sec. 1.882-5(b),
among the foreign corporation's direct interest in the top-tier
partnership and indirect interests in each lower-tier partnership in
proportion to their contribution to the portion of the foreign
corporation's interest in the upper-tier partnership that is a U.S.
asset. Each partnership interest's contribution is determined based on
a reasonable method consistent with the method
[[Page 56917]]
used to determine the portion of the top-tier partnership interest that
is a U.S. asset under Sec. 1.882-5(b).
(4) Limitation on attribution of excess Sec. 1.882-5 three-step
interest expense. The portion of excess Sec. 1.882-5 three-step
interest expense attributable to a foreign corporation under paragraph
(f)(1)(iii)(C)(2) of this section or to a partnership under paragraph
(f)(1)(iii)(C)(2) or (f)(1)(iii)(C)(3) of this section, as applicable,
is limited to interest on liabilities of the foreign corporation or the
foreign corporation's allocable share of liabilities of the
partnership, reduced by the sum of the amounts of interest expense on
its U.S. booked liabilities described in Sec. 1.882-5(d)(2) and
interest expense on liabilities described in Sec. 1.882-5(a)(1)(ii)(A)
or (B) (regarding direct allocations of interest expense). The portion
of any excess Sec. 1.882-5 three-step interest expense that would be
treated as attributable to the foreign corporation or a partnership
interest, as applicable, but for this paragraph (f)(1)(iii)(C)(4) is
re-attributable in accordance with the rules and principles of this
paragraph (f)(1)(iii)(C). The portion of any excess Sec. 1.882-5
three-step interest expense that cannot be re-attributed under the
rules of (f)(1)(iii)(C)(1) through (3) of this section because of the
application of the first sentence of this paragraph (f)(1)(iii)(C)(4)
is attributable, first to interest on liabilities of the foreign
corporation, and then, pro rata, to the foreign corporation's allocable
share of interest on liabilities of its direct or indirect partnership
interests, to the extent such attribution is not in excess of the
limitation described in this paragraph (f)(1)(iii)(C)(4), and without
regard to whether the foreign corporation or its partnership interests
have U.S. assets.
(2) Coordination with the branch profits tax. The disallowance and
carryforward of business interest expense under Sec. 1.163(j)-2(b) and
(c) will not affect the computation of the U.S. net equity of a foreign
corporation, as defined in Sec. 1.884-1(c).
(g) Definitions. The following definitions apply for purposes of
this section.
(1) Sec. 1.882-5 and similar provisions. The term Sec. 1.882-5
and similar provisions has the meaning provided in paragraph (f)(1)(i)
of this section.
(2) Sec. 1.882-5 three-step interest expense. The term Sec.
1.882-5 three-step interest expense has the meaning provided in
paragraph (f)(1)(iii)(A) of this section.
(3) Allocable ECI BIE. The term allocable ECI BIE means, with
respect to a partnership, the specified foreign partner's allocable
share of the partnership's business interest expense that is ECI,
taking into account the application of paragraph (e)(2) of this
section.
(4) Allocable ECI BII. The term allocable ECI BII has the meaning
provided in paragraph (c)(4)(ii) of this section.
(5) Allocable ECI deductible BIE. The term allocable ECI deductible
BIE has the meaning provided in paragraph (c)(3)(i) of this section.
(6) Allocable ECI excess BIE. The term allocable ECI excess BIE has
the meaning provided in paragraph (c)(2)(i) of this section.
(7) Allocable non-ECI BIE. The term allocable non-ECI BIE means,
with respect a partnership, the specified foreign partner's allocable
share of the partnership's business interest expense that is not ECI,
taking into account the application of paragraph (e)(2) of this
section.
(8) Allocable non-ECI deductible BIE. The term allocable non-ECI
deductible BIE has the meaning provided in paragraph (c)(3)(i) of this
section.
(9) Allocable non-ECI excess BIE. The term allocable non-ECI excess
BIE has the meaning provided in paragraph (c)(2)(ii) of this section.
(10) Distributive share of ECI. The term distributive share of ECI
has the meaning provided in paragraph (c)(1)(iii) of this section.
(11) Distributive share of non-ECI. The term distributive share of
non-ECI has the meaning provided in paragraph (c)(1)(iv) of this
section.
(12) Effectively connected income. The term effectively connected
income (or ECI) means income or gain that is ECI, as defined in Sec.
1.884-1(d)(1)(iii), and deduction or loss that is allocable to, ECI, as
defined in Sec. 1.884-1(d)(1)(iii).
(13) Excess Sec. 1.882-5 three-step interest expense. The term
excess Sec. 1.882-5 three-step interest expense has the meaning
provided in paragraph (f)(1)(iii)(C)(1) of this section.
(14) FC ECI BIE. The term FC ECI BIE means, with respect to a
relevant foreign corporation and a taxable year, business interest
expense that is ECI, determined without regard to the application of
section 163(j) and the section 163(j) regulations except for the
application of paragraph (f)(1)(iii) of this section.
(15) FC ECI deductible BIE. The term FC ECI deductible BIE has the
meaning provided in paragraph (d)(3)(i) of this section.
(16) FC ECI disallowed BIE. The term FC ECI disallowed BIE has the
meaning provided in paragraph (d)(2)(i) of this section.
(17) FC non-ECI BIE. The term FC non-ECI BIE means, with respect to
a relevant foreign corporation and a taxable year, business interest
expense that is not ECI, determined without regard to the application
of section 163(j) and the section 163(j) regulations except for the
application of paragraph (f)(1)(iii) of this section.
(18) FC non-ECI deductible BIE. The term FC non-ECI deductible BIE
has the meaning provided in paragraph (d)(3)(i) of this section.
(19) FC non-ECI disallowed BIE. The term FC non-ECI disallowed BIE
has the meaning provided in paragraph (d)(2)(ii) of this section.
(20) Hypothetical partnership ECI deductible BIE. The term
hypothetical partnership ECI deductible BIE has the meaning provided in
paragraph (c)(3)(iii)(A) of this section.
(21) Hypothetical partnership non-ECI deductible BIE. The term
hypothetical partnership non-ECI deductible BIE has the meaning
provided in paragraph (c)(3)(iii)(B) of this section.
(22) Hypothetical FC ECI deductible BIE. The term hypothetical FC
ECI deductible BIE has the meaning provided in paragraph (d)(3)(iii)(A)
of this section.
(23) Hypothetical FC non-ECI deductible BIE. The term hypothetical
FC non-ECI deductible BIE has the meaning provided in paragraph
(d)(3)(iii)(B) of this section.
(24) Specified ATI ratio. The term specified ATI ratio has the
meaning provided in paragraph (c)(1)(ii) of this section.
(25) Specified BII ratio. The term specified BII ratio has the
meaning provided in paragraph (c)(4)(ii) of this section.
(26) Specified foreign partner. The term specified foreign partner
means, with respect to a partnership that has ECI, a direct or indirect
partner that is a specified foreign person or a relevant foreign
corporation.
(27) Specified foreign person. The term specified foreign person
means a nonresident alien individual, as defined in section 7701(b) and
the regulations under section 7701(b), or a foreign corporation other
than a relevant foreign corporation.
(28) Successor. The term successor includes, with respect to a
foreign corporation, the acquiring corporation in a transaction
described in section 381(a) in which the foreign corporation is the
distributor or transferor corporation.
(h) Examples. The following examples illustrate the application of
this section. For all examples, assume that all referenced interest
expense is
[[Page 56918]]
deductible but for the application of section 163(j), the small
business exemption under Sec. 1.163(j)-2(d) is not available, no
entity is engaged in an excepted trade or business, no business
interest expense is floor plan financing interest expense, all entities
have the same taxable year, all entities use the U.S. dollar as their
functional currency, no foreign corporation is a relevant foreign
corporation, all relevant taxable years begin after December 31, 2020,
and, for purposes of computing ATI, none of the adjustments described
in Sec. 1.163(j)-1(b) are relevant other than the adjustment for
business interest expense.
(1) Example 1. Limitation on business interest deduction of a
foreign corporation--(i) Facts. FC, a foreign corporation, has $100x
of gross income that is ECI. FC has $60x of other income which is
not ECI. FC has total expenses of $100x, of which $50x is business
interest expense. Assume that FC has $30x of Sec. 1.882-5 three-
step interest expense. Under section 882(c) and the regulations, FC
has $40x of other expenses that are ECI, none of which are business
interest expense. FC does not have any business interest income. All
amounts described in this paragraph (h)(1)(i) are with respect to a
single taxable year of FC.
(ii) Analysis. FC is a specified foreign person under paragraph
(g)(27) of this section. The amount of FC's business interest
expense that is disallowed for the taxable year is determined under
Sec. 1.163(j)-2(b) with respect to business interest expense
described in paragraph (b)(3) of this section. Under paragraph
(b)(3) of this section, FC has business interest expense of $30x.
Under paragraph (b)(2) of this section, FC has ATI of $60x ($100x-
$40x). Accordingly, FC's section 163(j) limitation is $18x ($60x x
30 percent). Because FC's business interest expense ($30x) that is
ECI exceeds the section 163(j) limitation ($18x), FC may only deduct
$18x of business interest expense. Under Sec. 1.163(j)-2(c), the
remaining $12x is disallowed business interest expense carryforward,
and under paragraph (f)(1)(i) of this section, the $12x is not taken
into account for purposes of applying Sec. 1.882-5 in the
succeeding taxable year.
(2) Example 2. Use of a disallowed business interest expense
carryforward--(i) Facts. The facts are the same as in Example 1 in
paragraph (h)(1)(i) of this section except that for the taxable year
FC has $300x of gross income that is all ECI. Furthermore, assume
that for the taxable year FC has a disallowed business interest
expense carryforward of $25x with respect to business interest
expense described in paragraph (b)(3) of this section.
(ii) Analysis. Under paragraph (f)(1)(i) of this section, FC's
$25x of disallowed business interest expense carryforward is not
taken into account for purposes of determining FC's interest expense
under Sec. 1.882-5 for the taxable year. Therefore, FC has $30x of
Sec. 1.882-5 three-step interest expense. Under paragraph (b)(2) of
this section, FC has ATI of $260x ($300x of gross income reduced by
$40 of expenses other than business interest expense). Accordingly,
FC's section 163(j) limitation is $78x ($260x x 30 percent). Because
FC's business interest expense ($55x) does not exceed the section
163(j) limitation ($78x), FC may deduct all $55x of business
interest expense.
(3) Example 3. Foreign corporation is engaged in a U.S. trade or
business and is also a specified foreign partner--(i) Facts. FC, a
foreign corporation, owns a 50-percent interest in ABC, a
partnership that has ECI. In addition to owning a 50-percent
interest in ABC, FC conducts a separate business that is engaged in
a trade or business in the United States, Business Y. Business Y
produces $65x of taxable income before taking into account business
interest expense and has U.S. assets with an adjusted basis of
$300x, business interest expense of $15x on $160x of liabilities,
and no business interest income. All of the liabilities of Business
Y are U.S. booked liabilities for purposes of Sec. 1.882-5(d). FC
also has various foreign operations, some of which have U.S. dollar
denominated debt. ABC has two lines of business, Business S and
Business T. FC is allocated 50 percent of all items of income and
expense of Business S and Business T. Business S produces $140x of
taxable income before taking into account business interest expense,
and Business T produces $80x of taxable income before taking into
account business interest expense. Business S has business interest
expense of $20x on $400x of liabilities and no business interest
income. Business T has business interest expense of $10x on $150x of
liabilities and no business interest income. With respect to FC,
only Business S produces ECI. FC has an outside basis of $600x in
the portion of its ABC partnership interest that is a U.S. asset for
purposes of Sec. 1.882-5(b), step 1. All of the liabilities of
Business S are U.S. booked liabilities for purposes of Sec. 1.882-
5(d). FC computes its interest expense under the three-step method
described in Sec. 1.882-5(b) through (d) and for purposes of Sec.
1.882-5(c), step 2, FC uses the fixed ratio of 50 percent described
in Sec. 1.882-5(c)(4) for taxpayers that are neither a bank nor an
insurance company. Under Sec. 1.882-5(d)(5)(ii), FC's interest rate
on excess U.S. connected liabilities is 5 percent. For the taxable
year, assume FC has total interest expense of $100x for purposes of
Sec. 1.882-5(a)(3). All amounts described in this paragraph
(h)(3)(i) are with respect to a single taxable year of FC or ABC, as
applicable.
(ii) Analysis--(A) Application of Sec. 1.882-5 to FC. FC is a
specified foreign person under paragraph (g)(27) of this section and
a specified foreign partner under paragraph (g)(26) of this section.
Under paragraph (f)(1) of this section, FC first determines its
Sec. 1.882-5 three-step interest expense and then applies section
163(j). Under Sec. 1.882-5(b), step 1, FC has U.S. assets of $900x
($600x of basis in the portion of its ABC partnership interest that
is a U.S. asset determined using the asset method described in Sec.
1.884-1(d)(3)(ii) + $300x basis in U.S. assets of Business Y). Under
Sec. 1.882-5(c), step 2, applying the 50-percent fixed ratio
described in Sec. 1.882-5(c)(4), FC has U.S. connected liabilities
of $450x ($900x x 50 percent). Under Sec. 1.882-5(d), step 3, FC
has U.S. booked liabilities of $360x ($200x attributable to its 50-
percent share of Business S liabilities of ABC + $160x of Business Y
liabilities) and interest on U.S. booked liabilities of $25x ($10x
attributable to its 50-percent share of $20x interest expense of
Business S + $15x of Business Y interest expense). FC has excess
U.S. connected liabilities of $90x ($450x-$360x) and under Sec.
1.882-5(d)(5) has interest expense on excess U.S. connected
liabilities of $4.50x ($90x x 5 percent), which is excess Sec.
1.882-5 three-step interest expense. FC's Sec. 1.882-5 three-step
interest expense is $29.50x ($25x + $4.50x).
(B) Attribution of Sec. 1.882-5 business interest expense
between FC and ABC. Under paragraph (f)(1)(iii) of this section,
FC's Sec. 1.882-5 three-step interest expense is attributable to
interest on its liabilities or on its share of ABC liabilities.
Under paragraph (f)(1)(iii)(B), FC's Sec. 1.882-5 three-step
interest expense of $29.50x is first attributable to $15 of interest
expense on FC's (Business Y) U.S. booked liabilities and $10x of
interest expense on FC's share of U.S. booked liabilities of ABC.
Under paragraph (f)(1)(iii)(C)(2) of this section, of the excess
Sec. 1.882-5 three-step interest expense of $4.50x ($29.50x-$15x-
$10x), 66.67 percent ($600x of basis in the portion of the ABC
partnership interest that is a U.S. asset/$900x of total U.S.
assets), or $3.00x, is attributable to interest expense on FC's
share of liabilities of ABC and 33.33 percent ($300x U.S. assets
other than partnership interests/$900x of total U.S. assets), or
$1.50x, is attributable to interest expense on liabilities of FC. As
a result, $16.50x of business interest expense ($15x + $1.50x) is
attributed to FC and $13x of business interest expense ($10x + $3x)
is attributed to ABC. The limitation under paragraph
(f)(1)(iii)(C)(4) of this section does not change the result
described in the preceding sentence. Specifically, under paragraph
(f)(1)(iii)(C)(4) of this section, the amount attributed to ABC
(tentatively, $3.00x) is limited to $5x (FC's 50-percent share of
the $30x of business interest expense of ABC or $15x, reduced by
FC's 50-percent share of the $20x of business interest expense on
U.S. booked liabilities of Business S), and the amount attributed to
FC (tentatively, $1.50x) is limited to $70x (FC's business interest
expense of $100x, reduced by $15x of business interest expense on
U.S. booked liabilities of Business Y and its $15x allocable share
of ABC's business interest expense).
(C) Application of the section 163(j) limitation to ABC. Under
Sec. 1.163(j)-6(a), ABC computes a section 163(j) limitation at the
partnership level. ABC has business interest expense of $30x ($20x
from Business S and $10x from Business T). Under Sec. 1.163(j)-
6(d), ABC has ATI of $220x ($140 + $80). Under Sec. 1.163(j)-2(b),
ABC's section 163(j) limitation is $66x ($220x x 30 percent).
Because ABC's business interest expense ($30x) does not exceed the
section 163(j) limitation ($66x), all of ABC's business interest
expense is deductible for the taxable year.
(D) Excess taxable income of ABC. Under Sec. 1.163(j)-1(b)(15),
ABC has excess taxable
[[Page 56919]]
income of $120x ($220x x ($36x/$66x)). Under Sec. 1.163(j)-6(f)(2),
FC is allocated 50 percent of the $120x of ABC's excess taxable
income or $60x of allocable excess taxable income. Under paragraph
(c)(1) of this section, the amount of the allocable excess taxable
income of $60x that is ECI is equal to FC's allocable excess taxable
income multiplied by the specified ATI ratio. Under paragraph
(c)(1)(iii) of this section, FC's distributive share of ECI of ABC
is $57x (FC's 50-percent share of $140x (Business S income computed
without regard to business interest expense) or $70x-$13x of
business interest expense that is ECI). Under paragraph (c)(1)(iv)
of this section, FC's distributive share of non-ECI of ABC is $38x
(FC's 50-percent share of $80x (Business T income computed without
regard to business interest expense) or $40x-$2x of business
interest expense that is not ECI). FC's distributive share of
partnership items of income, gain, deduction, and loss of ABC is
$95x ($57x distributive share of ECI and $38x distributive share of
non-ECI). Because both FC's distributive share of ECI and
distributive share of non-ECI are positive, under paragraph
(c)(1)(ii) of this section, the specified ATI ratio is 60 percent
($57x distributive share of ECI/$95x distributive share of
partnership items of income, gain, deduction, and loss of ABC). As a
result, the amount of FC's allocable excess taxable income from ABC
that is ECI is $36x ($60 of allocable excess taxable income x 60
percent specified ATI ratio).
(E) Application of section 163(j) to FC. Under paragraph (b)(3)
of this section, FC's business interest expense is $16.50x. Under
Sec. 1.163(j)-6(e)(1), FC's ATI is determined under Sec. 1.163(j)-
1(b)(1) without regard to FC's distributive share of any items of
income, gain, deduction, or loss of ABC. Under paragraph (b)(2) of
this section, FC's ATI is $101x ($65x of ECI from Business Y + $36x
of allocable excess taxable income from ABC that is ECI). FC's
section 163(j) limitation is $30.30x ($101x x 30 percent). Because
FC's business interest expense ($16.50x) is less than FC's section
163(j) limitation ($30.30x) and all of its share of ABC's business
interest expense that is allocable to ECI ($13x) is deductible, FC
may deduct all $29.50x of Sec. 1.882-5 three-step interest expense
determined under paragraph (h)(3)(ii)(A) of this section.
(4) Example 4. Specified foreign partner with excess business
interest expense from a partnership--(i) Facts--(A) In general. FC,
a foreign corporation, owns a 50-percent interest in ABC, a
partnership that has ECI. In addition to owning a 50-percent
interest in ABC, FC conducts a separate business that is engaged in
a trade or business in the United States, Business Y. Business Y
produces $56x of taxable income before taking into account business
interest expense and has U.S. assets with an adjusted basis of
$800x, business interest expense of $16x on $200x of liabilities,
and no business interest income. All of the liabilities of Business
Y are U.S. booked liabilities for purposes of Sec. 1.882-5(d). FC
also has various foreign operations, some of which have U.S. dollar
denominated debt.
(B) ABC Partnership. ABC has two lines of business, Business S
and Business T, and owns a 50-percent interest in DEF, a
partnership. FC is allocated 50 percent of all items of income and
expenses of Business S and Business T and ABC's allocable share of
items from partnership DEF. Business S produces $80x of taxable
income before taking into account business interest expense, and
Business T produces $90x of taxable income before taking into
account business interest expense. Business S has business interest
expense of $30x on $500x of liabilities and no business interest
income. Business T has business interest expense of $50x on $500x of
liabilities and no business interest income. With respect to FC,
only Business S produces ECI. All of the liabilities of Business S
are U.S. booked liabilities for purposes of Sec. 1.882-5(d).
(C) DEF Partnership. DEF has two lines of business, Business U
and Business V. ABC is allocated 50 percent of all items of income
and expenses of Business U and Business V. Business U produces $100x
of taxable income before taking into account business interest
expense and Business V produces $140x of taxable income before
taking into account business interest expense. Business U has
business interest expense of $40x on $600x of liabilities and no
business interest income. Business V has business interest expense
of $60x on $600x of liabilities and no business interest income.
With respect to FC, only Business U produces ECI. All of the
liabilities of Business U are U.S. booked liabilities for purposes
of Sec. 1.882-5(d).
(D) Section 1.882-5. FC has an outside basis of $600x in the
portion of its ABC partnership interest that is a U.S. asset for
purposes of Sec. 1.882-5(b), step 1, determined using the asset
method described in Sec. 1.884-1(d)(3)(ii). For purposes of Sec.
1.884-1(d)(3)(ii), ABC has a total basis of $500 in assets that
would be treated as U.S. assets if ABC were a foreign corporation,
including a basis of $250x in the portion of its interest in DEF
partnership interest that would be treated as a U.S. asset if ABC
were a foreign corporation. FC computes its interest expense under
the three-step method described in Sec. 1.882-5(b) through (d), and
for purposes of Sec. 1.882-5(c), step 2, FC uses the fixed ratio of
50 percent described in Sec. 1.882-5(c)(4) for taxpayers that are
neither a bank nor an insurance company. FC has total interest
expense of $100x for purposes of Sec. 1.882-5(a)(3). Under Sec.
1.882-5(d)(5)(ii), FC's interest rate on excess U.S. connected
liabilities is 6 percent. All amounts described in this paragraph
(h)(4)(i) are with respect to a single taxable year of FC, ABC, or
DEF, as applicable.
(ii) Analysis--(A) Application of Sec. 1.882-5 to FC. FC is a
specified foreign person under paragraph (g)(27) of this section and
a specified foreign partner under paragraph (g)(26) of this section.
Under paragraph (f)(1) of this section, FC first determines its
Sec. 1.882-5 three-step interest expense and then applies section
163(j). Under Sec. 1.882-5(b), step 1, FC has U.S. assets of $1400x
($600x of basis in the portion of its ABC partnership interest that
is a U.S. asset + $800x basis in U.S. assets of Business Y). Under
Sec. 1.882-5(c), step 2, applying the 50-percent fixed ratio
described in Sec. 1.882-5(c)(4), FC has U.S. connected liabilities
of $700x ($1400x x 50 percent). Under Sec. 1.882-5(d), step 3, FC
has U.S. booked liabilities of $600x ($250x attributable to its 50-
percent share of Business S liabilities of ABC + $150x attributable
to its indirect 25-percent share of Business U liabilities of DEF +
$200x of Business Y liabilities), and interest on U.S. booked
liabilities of $41x ($15x attributable to its 50-percent share of
$30x interest expense of Business S + $10x attributable to its 25-
percent share of $40 interest expense of Business U + $16x of
Business Y interest expense). FC has excess U.S. connected
liabilities of $100x ($700x-$600x) and under Sec. 1.882-5(d)(5),
interest expense on excess U.S. connected liabilities of $6x ($100x
x 6 percent), which is excess Sec. 1.882-5 three-step interest
expense. FC's Sec. 1.882-5 three-step interest expense is $47x
($41x + $6x).
(B) Attribution of certain Sec. 1.882-5 business interest
expense among FC, ABC, and DEF. Under paragraph (f)(1)(iii) of this
section, FC's Sec. 1.882-5 three-step interest expense is
attributable to interest on its liabilities or on its share of ABC
and DEF's liabilities. Under paragraph (f)(1)(iii)(B) of this
section, FC's Sec. 1.882-5 three-step interest expense of $47x is
first attributable to $16 of interest expense on FC's U.S. booked
liabilities, $15x of interest expense on FC's share of U.S. booked
liabilities of ABC, and $10x of interest expense on FC's share of
U.S. booked liabilities of DEF. Under paragraph (f)(1)(iii)(C)(2) of
this section, of the excess Sec. 1.882-5 three-step interest
expense of $6x ($47x-$16x-$15x-$10x), 42.86 percent ($600x of basis
in the portion of the ABC partnership interest that is a U.S. asset/
$1400x of total U.S. assets) or $2.57x is attributable to interest
expense on FC's share of liabilities of ABC (and its partnership
interests), and 57.14 percent ($800x U.S. assets other than
partnership interests/$1400x of total U.S. assets) or $3.43x is
attributable to interest expense on liabilities of FC. Under
paragraph (f)(1)(iii)(C)(3) of this section, of the $2.57x of
business interest expense that is ECI and that is attributable to
interest expense on FC's share of liabilities of ABC (and its
partnership interests), 50 percent ($250x of basis in the portion of
the DEF partnership interest that would be a U.S. asset if ABC were
a foreign corporation/$500x total basis in assets that would be U.S.
assets if ABC were a foreign corporation), or $1.29x, is
attributable to interest expense on FC's share of liabilities of ABC
and 50 percent ($250x of basis in assets other than partnership
interests that would be U.S. assets if ABC were a foreign
corporation/$500x of total basis in assets that would be U.S. assets
if ABC were a foreign corporation), or $1.29x is attributable to
interest expense on FC's share of liabilities of DEF. As a result,
$19.43x ($16x + $3.43x) of business interest expense is attributed
to FC, $16.29x ($15x + $1.29x) of business interest expense is
attributed to ABC, and $11.29x ($10x + $1.29x) of business interest
expense is attributed to DEF. The limitation under paragraph
(f)(1)(iii)(C)(4) of this section does not change the result
described in the preceding sentence. Specifically, under paragraph
(f)(1)(iii)(C)(4) of this section, the amount attributed to FC
(tentatively, $3.43x)
[[Page 56920]]
is limited to $19x (FC's business interest expense of $100x, reduced
by $16x of business interest expense on U.S. booked liabilities of
Business Y, its $40x allocable share of ABC's business interest
expense, and its $25 allocable share of DEF's business interest
expense); the amount attributed to ABC (tentatively, $1.29x) is
limited to $25x (FC's 50-percent share of the $80x of business
interest expense of ABC, or $40x, reduced by FC's 50-percent share
of the $30x of business interest expense on U.S. booked liabilities
of Business S, or $15x); and the amount attributed to DEF
(tentatively, $1.29x) is limited to $15x (FC's 25-percent share of
the $100x of business interest expense of DEF, or $25x, reduced by
FC's 25-percent share of the $40x of business interest expense on
U.S. booked liabilities of Business U, or $10x).
(C) Application of section 163(j) to DEF--(1) In general. Under
Sec. 1.163(j)-6(a), DEF computes a section 163(j) limitation at the
partnership-level. DEF has business interest expense of $100x ($40x
from Business U + $60x from Business V). Under Sec. 1.163(j)-6(d),
DEF has ATI of $240x ($100x + $140x). Under Sec. 1.163(j)-2(b),
DEF's section 163(j) limitation is $72x ($240x x 30 percent).
Because DEF's business interest expense ($100x) exceeds the section
163(j) limitation ($72x), only $72x of DEF's business interest
expense is deductible and $28x is disallowed under section 163(j).
Pursuant to paragraph (e)(2) of this section, FC is allocated $7x of
excess business interest expense (25 percent x $28x) and $18x of
deductible business interest expense (25 percent x $72x).
(2) Deductible business interest expense. Under paragraph (c)(3)
of this section, in order to determine the portion of FC's allocable
deductible business interest expense ($18x) that is allocable ECI
deductible BIE and the portion that is allocable non-ECI deductible
BIE, the hypothetical partnership ECI deductible BIE and
hypothetical partnership non-ECI deductible BIE must be determined.
Under paragraph (c)(3)(iii)(A) of this section, FC's hypothetical
partnership ECI deductible BIE with respect to DEF is $7.50x ($25x
of FC's allocable share of ECI before taking into account interest
expense x 30 percent). Under paragraph (c)(3)(iii)(B) of this
section, FC's hypothetical partnership non-ECI deductible BIE with
respect to DEF is $10.50x ($35x of FC's allocable share of income
that is not ECI before taking into account interest expense x 30
percent). Under paragraph (c)(3)(i) of this section, allocable ECI
deductible BIE is equal to the amounts described in paragraphs
(c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of this section and
allocable non-ECI deductible BIE is equal to the amounts described
in paragraphs (c)(3)(ii)(A)(1)(ii) and (c)(3)(ii)(B)(2) of this
section. Under paragraph (c)(3)(ii)(A)(1) of this section, FC's
allocable deductible business interest expense ($18x) is allocated
pro rata between hypothetical partnership ECI deductible BIE
($7.50x) and hypothetical partnership non-ECI deductible BIE
($10.50x). However, the amount allocated to hypothetical partnership
ECI deductible BIE cannot exceed the lesser of hypothetical
partnership ECI deductible BIE ($7.50x) or allocable ECI BIE
($11.29x), and the amount allocated to hypothetical partnership non-
ECI deductible BIE cannot exceed the lesser of hypothetical
partnership non-ECI deductible BIE ($10.50x) or allocable non-ECI
BIE (total allocable business interest expense of $25x reduced by
allocable ECI BIE of $11.29x, or $13.71x). The portion of FC's
allocable deductible business interest expense ($18x) from DEF that
is allocable ECI deductible BIE is 41.67 percent ($7.50x of
hypothetical partnership ECI deductible BIE/$18x of total
hypothetical partnership deductible BIE), or $7.5x. The portion of
FC's allocable deductible business interest expense from DEF ($18x)
that is allocable non-ECI deductible BIE is 58.33 percent ($10.50x
of hypothetical partnership ECI deductible BIE/$18x of total
hypothetical partnership deductible BIE), or $10.50x. Because the
full amount of FC's allocable deductible business interest expense
($18x) is allocable under paragraph (c)(3)(ii)(A)(1) of this
section, no portion is allocated under paragraph (c)(3)(ii)(B) of
this section.
(3) Excess business interest expense. Under paragraph (c)(2)(i)
of this section, the portion of excess business interest expense
allocated to FC from DEF pursuant to paragraph (e)(2) of this
section ($7x) that is allocable ECI excess BIE is $3.79x ($11.29x of
allocable ECI BIE-$7.50x allocable ECI deductible BIE). Under
paragraph (c)(2)(ii) of this section, the portion of excess business
interest expense allocated to FC from DEF pursuant to paragraph
(e)(2) of this section ($7x) that is allocable non-ECI excess BIE is
$3.21x ($13.71x of allocable non-ECI BIE-$10.50x allocable non-ECI
deductible BIE).
(D) Application of section 163(j) to ABC--(1) In general. Under
Sec. 1.163(j)-6(a), ABC computes a section 163(j) limitation at the
partnership-level. ABC has business interest expense of $80x ($30x
from Business S + $50x from Business T). Under Sec. 1.163(j)-6(d),
ABC has ATI of $170x ($80x + $90x). Under Sec. 1.163(j)-2(b), ABC's
section 163(j) limitation is $51x ($170x x 30 percent). Because
ABC's business interest expense ($80x) exceeds the section 163(j)
limitation ($51x), ABC may only deduct $51x of business interest
expense, and $29x is disallowed under section 163(j). Pursuant to
Sec. 1.163(j)-6(f)(2), FC is allocated $14.50x of excess business
interest expense (50 percent x $29x) and $25.50x of deductible
business interest expense (50 percent x $51x).
(2) Deductible business interest expense. Under paragraph (c)(3)
of this section, in order to determine the portion of FC's allocable
deductible business interest expense ($25.50x) that is allocable ECI
deductible BIE and the portion that is allocable non-ECI deductible
BIE, the hypothetical partnership ECI deductible BIE and
hypothetical partnership non-ECI deductible BIE must be determined.
Under paragraph (c)(3)(iii)(A) of this section, FC's hypothetical
partnership ECI deductible BIE with respect to ABC is $12x ($40x of
FC's allocable share of ECI before taking into account interest
expense x 30 percent). Under paragraph (c)(3)(iii)(B) of this
section, FC's hypothetical partnership non-ECI deductible BIE with
respect to ABC is $13.50x ($45x of FC's allocable share of income
that is not ECI before taking into account interest expense x 30
percent). Under paragraph (c)(3)(i) of this section, allocable ECI
deductible BIE is equal to the amounts described in paragraphs
(c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of this section and
allocable non-ECI deductible BIE is equal to the amounts described
in paragraphs (c)(3)(ii)(A)(1)(ii) and (c)(3)(ii)(B)(2) of this
section. Under paragraph (c)(3)(ii)(A)(1) of this section, FC's
allocable deductible business interest expense ($25.50x) is
allocated pro rata between hypothetical partnership ECI deductible
BIE ($12x) and hypothetical partnership non-ECI deductible BIE
($13.50x). However, the amount allocated to hypothetical partnership
ECI deductible BIE cannot exceed the lesser of hypothetical
partnership ECI deductible BIE ($12x) or allocable ECI BIE
($16.29x), and the amount allocated to hypothetical partnership non-
ECI deductible BIE cannot exceed the lesser of hypothetical
partnership non-ECI deductible BIE ($13.50x) or allocable non-ECI
BIE (total allocable business interest expense of $40x reduced by
allocable ECI BIE of $16.29x, or $23.71x). The portion of FC's
allocable deductible business interest expense from ABC ($25.50x)
that is allocable ECI deductible BIE is 47.06 percent ($12x of
hypothetical partnership ECI deductible BIE/$25.50x of total
hypothetical partnership deductible BIE), or $12x. The portion of
FC's allocable deductible business interest expense from ABC that is
allocable non-ECI deductible BIE is 52.94 percent ($13.50x of
hypothetical partnership ECI deductible BIE/$25.50x of total
hypothetical partnership deductible BIE), or $13.50x. Because the
full amount of FC's allocable deductible business interest expense
($25.50x) is allocable under paragraph (c)(3)(ii)(A)(1) of this
section, no portion is allocated under paragraph (c)(3)(ii)(B) of
this section.
(3) Excess business interest expense. Under paragraph (c)(2)(i)
of this section, the portion of excess business interest expense
allocated to FC from ABC pursuant to Sec. 1.163(j)-6(f)(2)($14.50x)
that is allocable ECI excess BIE is $4.29x ($16.29x of allocable ECI
BIE-$12x allocable ECI deductible BIE). Under paragraph (c)(2)(ii)
of this section, the portion of excess business interest expense
allocated to FC from ABC pursuant to Sec. 1.163(j)-6(f)(2)
($14.50x) that is allocable non-ECI excess BIE is $10.21x ($23.71x
of allocable non-ECI BIE-$13.50x allocable non-ECI deductible BIE).
(E) Application of section 163(j) to FC. Under paragraph (b)(3)
of this section, FC's business interest expense is $19.43x. Under
Sec. 1.163(j)-6(e)(1), FC's ATI is determined under Sec. 1.163(j)-
1(b)(1) without regard to FC's distributive share of any items of
income, gain, deduction, or loss of ABC or DEF. Under paragraph
(b)(2) of this section, FC's ATI is $56x ($56x of ECI of Business Y
before taking into account interest expense). FC's section 163(j)
limitation is $16.80x ($56x x 30 percent). Because the portion of
FC's business interest expense determined under Sec. 1.882-5 that
is attributed to FC ($19.43x) exceeds the section 163(j) limitation
($16.80x), FC may only deduction $16.80x of business interest
expense, and $2.63x is disallowed business interest
[[Page 56921]]
expense carryforward. After taking into account FC's allocable share
of deductible business interest expense, FC may deduct $36.30x
($16.80x from FC + $12x allocable ECI deductible BIE from ABC +
$7.50x allocable ECI deductible BIE from DEF). FC also has $2.63x
disallowed business interest expense carryforward characterized as
ECI, $4.29x allocable ECI excess BIE from ABC, $10.21x allocable
non-ECI excess BIE from ABC, and, under paragraph (e)(2) of this
section, is deemed to have $3.79x allocable ECI excess BIE from DEF
and $3.21x allocable non-ECI excess BIE from DEF.
(i) [Reserved]
(j) Applicability date. This section applies to taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER]. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b)(1),
may choose to apply this section in its entirety for a taxable year
beginning after December 31, 2017, so long as the taxpayers and their
related parties also apply Sec. 1.163(j)-7(a), (c) through (f), (g)(3)
and (4), and (h) through (k) for the taxable year. For a taxable year
beginning before November 13, 2020, taxpayers and their related parties
may not choose to apply this section unless they also apply Sec.
1.163(j)-7(b) and (g)(1) and (2) in accordance with the second sentence
of Sec. 1.163(j)-7(m)(1).
0
Par. 10. As added in a final rule elsewhere in this issue of the
Federal Register, effective November 13, 2020, Sec. 1.163(j)-10 is
amended by:
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1. Designating paragraph (c)(5)(ii)(D) as paragraph (c)(5)(ii)(D)(1).
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2. Adding a subject heading for paragraph (c)(5)(ii)(D).
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3. Adding paragraph (c)(5)(ii)(D)(2).
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4. Designating paragraph (f) as paragraph (f)(1).
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5. Adding a subject heading for paragraph (f).
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6. Revising the subject heading of newly redesignated paragraph (f)(1).
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7. Adding paragraph (f)(2).
The additions and revision read as follows:
1.163(j)-10 Allocation of interest expense, interest income, and other
items of expense and gross income to an excepted trade or business.
* * * * *
(c) * * *
(5) * * *
(ii) * * *
(D) Limitations on application of look-through rules. * * *
(2) Limitation on application of look-through rule to C
corporations. Except as provided in Sec. 1.163(j)-9(h)(4)(iii) and
(iv) (for a REIT or a partnership making the election under Sec.
1.163(j)-9(h)(1) or (7), respectively), for purposes of applying the
look-through rules in paragraph (c)(5)(ii)(B) and (C) of this section
to a non-consolidated C corporation (upper-tier entity), that upper-
tier entity may not apply these look-through rules to a lower-tier non-
consolidated C corporation. For example, assume that P wholly and
directly owns S1 (the upper-tier entity), which wholly and directly
owns S2. Further assume that each of these entities is a non-
consolidated C corporation to which the small business exemption does
not apply. S1 may not look through the stock of S2 (and may not apply
the asset basis look-through rule described in paragraph
(c)(5)(ii)(B)(2)(iv) of this section) for purposes of P's allocation of
its basis in its S1 stock between excepted and non-excepted trades or
businesses; instead, S1 must treat its stock in S2 as an asset used in
a non-excepted trade or business for that purpose. However, S1 may look
through the stock of S2 for purposes of S1's allocation of its basis in
its S2 stock between excepted and non-excepted trades or businesses.
* * * * *
(f) Applicability dates.
(1) In general. * * *
(2) Paragraph (c)(5)(ii)(D)(2). The rules contained in paragraph
(c)(5)(ii)(D)(2) of this section apply for taxable years beginning on
or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN
THE FEDERAL REGISTER]. However, taxpayers may choose to apply the rules
of paragraph (c)(5)(ii)(D)(2) of this section to a taxable year
beginning after December 31, 2017, and before [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER], so long as
they consistently apply the rules in the section 163(j) regulations,
and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.383-0, 1.383-1, 1.469-9, 1.704-1,
1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79,
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4 to
that taxable year and each subsequent taxable year.
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Par. 11. Section 1.469-4 is amended by adding paragraph (d)(6) to read
as follows:
Sec. 1.469-4 Definition of activity.
* * * * *
(d) * * *
(6) Activities described in section 163(d)(5)(A)(ii). An activity
described in section 163(d)(5)(A)(ii) that involves the conduct of a
trade or business which is not a passive activity of the taxpayer and
with respect to which the taxpayer does not materially participate may
not be grouped with any other activity or activities of the taxpayer,
including any other activity described in section 163(d)(5)(A)(ii).
* * * * *
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Par. 12. As amended in a final rule elsewhere in this issue of the
Federal Register, effective November 13, 2020, Sec. 1.469-9 is further
amended by revising paragraphs (b)(2)(ii)(A) and (B) to read as
follows:
Sec. 1.469-9 Rules for certain rental real estate activities.
* * * * *
(b) * * *
(2) * * *
(ii) * * *
(A) Real property development. The term real property development
means the maintenance and improvement of raw land to make the land
suitable for subdivision, further development, or construction of
residential or commercial buildings, or to establish, cultivate,
maintain or improve timberlands (that is, land covered by timber-
producing forest). Improvement of land may include any clearing (such
as through the mechanical separation and removal of boulders, rocks,
brush, brushwood, and underbrush from the land); excavation and
gradation work; diversion or redirection of creeks, streams, rivers, or
other sources or bodies of water; and the installation of roads
(including highways, streets, roads, public sidewalks, and bridges),
utility lines, sewer and drainage systems, and any other infrastructure
that may be necessary for subdivision, further development, or
construction of residential or commercial buildings, or for the
establishment, cultivation, maintenance or improvement of timberlands.
(B) Real property redevelopment. The term real property
redevelopment means the demolition, deconstruction, separation, and
removal of existing buildings, landscaping, and infrastructure on a
parcel of land to return the land to a raw condition or otherwise
prepare the land for new development or construction, or for the
establishment and cultivation of new timberlands.
* * * * *
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Par. 13. Section 1.469-11 is amended by revising paragraphs (a)(1) and
(4) to read as follows:
Sec. 1.469-11 Applicability date and transition rules.
(a) * * *
[[Page 56922]]
(1) The rules contained in Sec. Sec. 1.469-1, 1.469-1T, 1.469-2,
1.469-2T, 1.469-3, 1.469-3T, 1.469-4, but not Sec. 1.469-4(d)(6),
1.469-5 and 1.469-5T apply for taxable years ending after May 10, 1992.
The rules contained in Sec. 1.469-4(d)(6) apply for taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER]. However, taxpayers and their
related parties, within the meaning of sections 267(b) and 707(b), may
choose to apply the rules of Sec. 1.469-4(d)(6) to a taxable year
beginning after December 31, 2017, and before [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER], so long as
they consistently apply the rules in the section 163(j) regulations,
and, if applicable, Sec. Sec. 1.263A-9, 1.263A-15, 1.381(c)(20)-1,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.383-0, 1.383-1, 1.469-9, 1.704-1,
1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-79,
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of
Sec. Sec. 1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4 to
that taxable year and each subsequent taxable year.
* * * * *
(4) The rules contained in Sec. 1.469-9(b)(2), other than
paragraphs (b)(2)(ii)(A) and (B), apply to taxable years beginning on
or after [INSERT DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL
RULE IN THE FEDERAL REGISTER]. Section 1.469-9(b)(2)(ii)(A) and (B)
applies to taxable years beginning on or after [DATE 60 DAYS AFTER DATE
OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER]. However,
taxpayers and their related parties, within the meaning of sections
267(b) and 707(b)(1), may choose to apply the rules of Sec. 1.469-
9(b)(2), other than paragraphs (b)(2)(ii)(A) and (B), to a taxable year
beginning after December 31, 2017, and before [INSERT DATE 60 DAYS
AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE FEDERAL REGISTER]
and may choose to apply the rules contained in 1.469-9(b)(2)(ii)(A) and
(B) to taxable years beginning after December 31, 2017, and before
[DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE FINAL RULE IN THE
FEDERAL REGISTER], so long as they consistently apply the rules of the
section 163(j) regulations, and, if applicable, Sec. Sec. 1.263A-9,
1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.383-0,
1.383-1, 1.469-9, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1,
1.1502-13, 1.1502-21, 1.1502-79, 1.1502-91 through 1.1502-99 (to the
extent they effectuate the rules of Sec. Sec. 1.382-2, 1.382-5, 1.382-
6, and 1.383-1), and 1.1504-4 to that taxable year and each subsequent
taxable year.
* * * * *
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Par. 14. Section 1.1256(e)-2 is added to read as follows:
Sec. 1.1256 (e)-2 Special rules for syndicates.
(a) Allocation of losses. For purposes of section 1256(e)(3),
syndicate means any partnership or other entity (other than a
corporation that is not an S corporation) if more than 35 percent of
the losses of such entity during the taxable year are allocated to
limited partners or limited entrepreneurs (within the meaning of
section 461(k)(4)).
(b) Determination of loss amount. For purposes of section
1256(e)(3), the amount of losses to be allocated under paragraph (a) of
this section is calculated without regard to section 163(j).
(c) Example. The following example illustrates the rules in this
section:
(1) Facts. Entity is an S corporation that is equally owned by
individuals A and B. A provides all of the goods and services
provided by Entity. B provided all of the capital for Entity but
does not participate in Entity's business. For the current taxable
year, Entity has gross receipts of $5,000,000, non-interest expenses
of $4,500,000, and interest expense of $600,000.
(2) Analysis. Under paragraph (b) of this section, Entity has a
net loss of $100,000 ($5,000,000 minus $5,100,000) for the current
taxable year. One half (50 percent) of this loss is allocated to B,
a limited owner. Therefore, for the current taxable year, Entity is
a syndicate within the meaning of section 1256(e)(3)(B).
(d) Applicability date. This section applies to taxable years
beginning on or after [DATE 60 DAYS AFTER DATE OF PUBLICATION OF THE
FINAL RULE IN THE FEDERAL REGISTER]. However, taxpayers and their
related parties, under sections 267(b) and 707(b)(1), may choose to
apply the rules of this section for a taxable year beginning after
December 31, 2017, and before [DATE 60 DAYS AFTER DATE OF PUBLICATION
OF THE FINAL RULE IN THE FEDERAL REGISTER], provided that they
consistently apply the rules of this section to that taxable year and
each subsequent taxable year.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-16532 Filed 9-3-20; 4:15 pm]
BILLING CODE 4830-01-P