Expertise Beyond the Numbers

2020 Proposed Regulations – Section 163(j) Business Interest Expense Limitation

Along with the Section 163(j) final regulations, new proposed regulations were also issued on July 28, 2020 which address complex issues for partnerships and controlled foreign corporations (CFCs).

Summary of Proposed Regulations

  • Proposed modifications to 163(j)
    • “Lesser of” approach: lesser of a) amount of gain on sale/disposition of other property or b) 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.
    • The “lesser of” concept was removed with final regulations but is allowed under the new proposed regulations. When using this approach, it must be consistently applied for all sales and dispositions otherwise subject to 163(j)-1(b)(1)(ii)(C), (D) or (E) or when the taxpayer computes tentative taxable income.
  • Allocation of interest expense for passthrough entities
    • Background: The 2018 proposed regulations, in tandem with Notice 89-35, failed to include rules to address the application of 1.163-8T to passthrough entities.
      • Notice 89-35 addressed debt-financed acquisition of an interest in a passthrough entity by purchase and provided that interest expense of the owner of the passthrough entity should be allocated among the assets of the entity using any reasonable method.
      • Notice 89-35 also addressed debt-financed distributions by providing both a general and optional allocation rule.
      • Expenditures listed in 1.163-8T did not adequately account for use of debt proceeds by a passthrough entity
    • Proposed Section 1.163-14 – Modification to tracing of debt proceeds and related interest expense: proposes that distributed debt proceeds are first allocated to the passthrough entity’s available .
    • After this initial allocation, a further allocation is made to determine treatment of each partner’s allocable interest expense (3 categories):
      • Debt financed distribution interest expense
      • Expenditure interest expense
      • Excess interest expense
  • Proposed modifications on the application of 163(j) expense limitation to Partnerships
    • Trading partnerships: Interest expense and all other items of income, gain, loss and deduction must be bifurcated between partners that materially participate and partners that are passive investors. Only interest expense allocated to partners who materially participate is subject to the 163(j) limitation.
    • Publicly traded partnerships: these entities are permitted to apply a Section 704(b) approach (not 704(c)) in allocating Section 163(j) excess items in order to prevent PTP units from lacking fungibility.
    • Treatment of excess business interest expense (EBIE) in tiered partnerships: EBIE should follow the “entity approach” whereas EBIE allocated from a lower-tier partnership allocated to an upper-tier partnership does not get further allocated to partners’ of the upper-tier partnership.
    • Self-charged lending transactions: Borrowing from the rules under IRC 469 and self-charged interest, the proposed regulations state that business interest expense generated in this type of transaction that is allocated from the borrowing partner to the lending partner can be offset to the extent that the lending partner received corresponding business interest income in the transaction. Business interest income in excess of the EBIE allocation should be treated as investment income.
    • Basis adjustments upon partner dispositions: an inside basis partnership adjustment is required to correspond with an outside basis partner adjustment due to the partner’s interest in any unused EBIE that remains upon disposition. This inside basis adjustment may not be depreciated or amortized.
  • Application to CFC’s
    • New CFC group election:
      • Step 1 – identify members of specified group, of which the specified period of these members must match that of the specified group parent.
      • Step 2 – determine the CFC group limitation
      • Step 3 – apply the CFC group limitation to sum of members’ BIE (if limitation > sum, no BIE disallowed; if limitation < sum, members’ may deduct BIE up to BII, then remaining BIE deduction determined based on allocable share of group limitation)
      • Group election remains in effect for 5 years and is nonrevocable
      • The election must be made by due date of CFC group parent’s tax return, including extensions
    • New annual safe harbor election: this new election can be made if CFC group’s BIE does not exceed 30% of lesser of a) sum of “eligible amounts” of each CFC group member or b) sum of “qualified tentative taxable income” of each CFC group member
      • Once made, no BIE is disallowed for any CFC group member, along with no excess taxable income being includable in the U.S. shareholder’s ATI
      • The election must be made by due date of CFC group parent’s tax return, including extensions
      • The CFC group election must be in effect for an annual safe harbor election to be made

Effective Dates

The 2020 proposed regulations will generally apply to tax years beginning 60 days after the date they are published as final regulations in the Federal Register.