I

106TH CONGRESS

1ST SESSION H. R. 2270

To amend the Internal Revenue Code of 1986 to reform the interest allocation

rules.

IN THE HOUSE OF REPRESENTATIVES

JUNE 17, 1999

Mr. PORTMAN (for himself and Mr. MATSUI) introduced the following bill;

which was referred to the Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to reform

the interest allocation rules.

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,

3 SECTION. 1. SHORT TITLE.

4 This Act may be cited as the ‘‘Interest Allocation Re5 form Act’’.

6 SEC. 2. INTEREST ALLOCATION RULES.

7 (a) IN GENERAL.—Section 864 of the Internal Rev8 enue Code of 1986 (relating to definitions and special

9 rules with respect to source rules and general rules relat10 ing to foreign income) is amended by redesignating sub-
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1 section (f) as subsection (g) and by inserting after sub2 section (e) the following new subsection:

3 ‘‘(f) ELECTION WITH RESPECT TO INTEREST ALLO4 CATION.—For purposes of this subchapter—

5 ‘‘(1) ELECTION.—

6 ‘‘(A) IN GENERAL.—If a member of an af7 filiated group so elects, this subsection shall

8 apply in lieu paragraphs (1) and (5) of sub9 section (e) for purposes of all allocations and

10 apportionments of interest expense.

11 ‘‘(B) WHEN MADE; APPLICATION.—An

12 election under this paragraph may be made

13 only for the taxpayer’s first taxable year for

14 which this subsection is effective and for which

15 the taxpayer is a member of an affiliated group.

16 An election under this paragraph shall apply to

17 all members of the affiliated group. An election

18 under this paragraph, once made, shall apply to

19 the taxable year for which made and all subse20 quent years unless revoked with the consent of

21 the Secretary.

22 ‘‘(2) TREATMENT OF AFFILIATED GROUPS.—

23 Except as otherwise provided in this subsection, the

24 taxable income of an affiliated group from sources

25 outside the United States shall be determined by al-
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1 locating and apportioning interest expense to such

2 income in an amount equal to—

3 ‘‘(A) the total interest expense of the ex4 panded affiliated group which includes such af5 filiated group, multiplied by

6 ‘‘(B) a percentage equal to the ratio which

7 the foreign assets of the expanded affiliated

8 group bears to all assets of the expanded affili9 ated group.

10 ‘‘(3) TREATMENT OF FOREIGN SUBSIDIARY IN11 TEREST EXPENSE.—Interest expense allocated to

12 foreign source income under the rules of paragraph

13 (2) shall be reduced (but not below zero) by any in14 terest expense incurred by any foreign corporation in

15 the expanded affiliated group to the extent such in16 terest would have been allocated and apportioned to

17 foreign source income of such corporation if this

18 subsection were applied to a group consisting of all

19 the foreign corporations in the expanded affiliated

20 group. A similar reduction shall be made in the case

21 of a corporation described in section 1504(b)(4).

22 ‘‘(4) BASIS OF STOCK IN CERTAIN CORPORA23 TIONS ADJUSTED FOR EARNINGS AND PROFITS.—

24 The basis adjustment rules of subsection (e)(4) shall

25 be applied only to stock in a corporation which is
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1 not included in the expanded affiliated group and in

2 which members of the expanded affiliated group own

3 10 percent or more of the total combined voting

4 power of all classes of stock entitled to vote.

5 ‘‘(5) EXCEPTION FOR INTEREST EXPENSE OF

6 CERTAIN DOMESTIC SUBSIDIARIES.—

7 ‘‘(A) IN GENERAL.—A domestic corpora8 tion which is a member of an affiliated group

9 and which incurs interest expense with respect

10 to qualified indebtedness (as defined in sub11 paragraph (C)) may elect to allocate and appor12 tion interest expense incurred with respect to

13 such qualified indebtedness under the rules of

14 this subsection as if such corporation were the

15 common parent of an expanded affiliated group

16 consisting of such domestic corporation and any

17 corporation at a lower level in the chain of cor18 porations that includes such domestic corpora19 tion.

20 ‘‘(B) EQUALIZATION RULE.—If an election

21 under subparagraph (A) is made by any mem22 ber of an affiliated group, all interest expense

23 of such affiliated group not incurred with re24 spect to qualified indebtedness shall be allo25 cated and apportioned to foreign source income
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1 to the extent such expense does not exceed the

2 amount of all interest expense which, but for

3 this paragraph, would have been so allocated

4 and apportioned.

5 ‘‘(C) QUALIFIED INDEBTEDNESS.—For

6 purposes of this paragraph, qualified indebted7 ness means any borrowing from any unrelated

8 party which is not guaranteed (or otherwise di9 rectly supported) by any corporation within the

10 same expanded affiliated group as the borrower

11 (other than a corporation at a lower level in the

12 chain of includible corporations). If a borrowing

13 is not treated as qualified indebtedness solely

14 because it is guaranteed (or otherwise directly

15 supported) by another corporation, then—

16 ‘‘(i) such borrowing shall be treated

17 as the borrowing of such other corporation

18 if such other corporation is at a higher

19 level in the chain of includible corporations

20 than the borrowing corporation, or

21 ‘‘(ii) if such other corporation is in a

22 different chain of includible corporations,

23 such borrowing shall be treated as the bor24 rowing of the first common parent of the
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1 borrowing corporation and the guaran2 teeing corporation.

3 ‘‘(D) EFFECT OF CERTAIN TRANSACTIONS

4 ON QUALIFIED INDEBTEDNESS.—To the extent

5 that a domestic corporation allocating interest

6 expense under the rules of subparagraph (A)—

7 ‘‘(i) distributes dividends or makes

8 other distributions with respect to its stock

9 in any year to any member of its affiliated

10 group in excess of the greater of—

11 ‘‘(I) its average annual dividend

12 (expressed as a percentage of current

13 earnings and profits) during the 5

14 taxable year period ending with the

15 taxable year preceding the taxable

16 year, or

17 ‘‘(II) 25 percent of its average

18 annual earnings and profits for such 5

19 taxable year period, or

20 ‘‘(ii) deals with any related party in

21 any manner not clearly reflecting the in22 come of the corporation,

23 an amount of qualified indebtedness equal to

24 the excess distribution or the understatement or

25 overstatement of income, as the case may be,
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1 shall be recharacterized for purposes of this

2 paragraph as nonqualified indebtedness. If a

3 corporation has not been in existence for 5 tax4 able years, this subparagraph shall be applied

5 with respect to the period it was in existence.

6 ‘‘(E) EFFECT OF ELECTION ON GROUP.—

7 If 1 member of an affiliated group makes an

8 election under subparagraph (A), all members

9 of such group shall be treated as having made

10 such election.

11 ‘‘(6) TREATMENT OF CERTAIN FINANCIAL IN12 STITUTIONS.—

13 ‘‘(A) IN GENERAL.—Any corporation that

14 is predominantly engaged in the active conduct

15 of a banking, insurance, financing, or similar

16 business may elect to be treated as a member

17 of an affiliated or expanded affiliated group

18 only for purposes of applying this subsection to

19 corporations so engaged.

20 ‘‘(B) DEFINITION.—A corporation shall be

21 considered to be predominantly engaged in a

22 banking, insurance, financing, or similar busi23 ness if at least 80 percent of its gross income

24 is income described in section 904(d)(2)(C)(ii)

25 and the regulations thereunder.
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1 ‘‘(C) EFFECT OF CERTAIN TRANS2 ACTIONS.—Rules similar to the rules of para3 graph (5)(D) shall apply in the case of trans4 actions between a corporation included in the

5 group described in subparagraph (A) and an6 other member of the affiliated group that is not

7 included in the group described in subpara8 graph (A).

9 ‘‘(D) EFFECT OF ELECTION ON GROUP.—

10 If 1 member of an affiliated group makes an

11 election under subparagraph (A), all members

12 of such group shall be treated as having made

13 such election.

14 ‘‘(7) AFFILIATED GROUP.—For purposes of this

15 subsection—

16 ‘‘(A) AFFILIATED GROUP.—The term ‘af17 filiated group’ has the meaning given by such

18 term in section 1504(a) (determined without re19 gard to paragraph (2) of section 1504(b)).

20 ‘‘(B) EXPANDED AFFILIATED GROUP.—

21 The term ‘expanded affiliated group’ means an

22 affiliated group determined without regard to

23 paragraph (2), (3), or (4) of section 1504(b)

24 (but does not include a FSC as defined in sec25 tion 922(a)).
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1 ‘‘(8) REGULATIONS.—The Secretary shall pre2 scribe regulations providing for the direct allocation

3 of interest expense in other circumstances where

4 such allocation would be necessary or appropriate to

5 carry out the purposes of this subsection.’’

6 (b) CONFORMING AMENDMENT.—Subsection (e) of

7 section 864 is amended by striking ‘‘subchapter—’’ and

8 inserting ‘‘subchapter, except as provided in subsection

9 (f)—’’.

10 (c) EFFECTIVE DATE.—The amendments made by

11 this section shall apply to taxable years ending after De12 cember 31, 1999.

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