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.
Be it enacted by the Senate and House of Representa-
tives of the United States of America in Congress assembled,
SECTION. 1. SHORT TITLE.
This Act may be cited as the ‘‘Interest Allocation Re-
form Act’’.
SEC. 2. INTEREST ALLOCATION RULES.
(a) IN GENERAL.—Section 864 of the Internal Rev-
enue Code of 1986 (relating to definitions and special
rules with respect to source rules and general rules relat-
ing to foreign income) is amended by redesignating sub-
section (f) as subsection (g) and by inserting after sub-
section (e) the following new subsection:
‘‘(f) ELECTION WITH RESPECT TO INTEREST ALLO-
CATION.—For purposes of this subchapter—
‘‘(1) ELECTION.—
‘‘(A) IN GENERAL.—If a member of an af-
filiated group so elects, this subsection shall
apply in lieu paragraphs (1) and (5) of sub-
section (e) for purposes of all allocations and
apportionments of interest expense.
‘‘(B) WHEN
MADE; 
APPLICATION.—An
election under this paragraph may be made
only for the taxpayer’s first taxable year for
which this subsection is effective and for which
the taxpayer is a member of an affiliated group.
An election under this paragraph shall apply to
all members of the affiliated group. An election
under this paragraph, once made, shall apply to
the taxable year for which made and all subse-
quent years unless revoked with the consent of
the Secretary.
‘‘(2) TREATMENT
OF
AFFILIATED
GROUPS.—
Except as otherwise provided in this subsection, the
taxable income of an affiliated group from sources
outside the United States shall be determined by al-
locating and apportioning interest expense to such
income in an amount equal to—
‘‘(A) the total interest expense of the ex-
panded affiliated group which includes such af-
filiated group, multiplied by
‘‘(B) a percentage equal to the ratio which
the foreign assets of the expanded affiliated
group bears to all assets of the expanded affili-
ated group.
‘‘(3) TREATMENT OF FOREIGN SUBSIDIARY IN-
TEREST
EXPENSE.—Interest expense allocated to
foreign source income under the rules of paragraph
(2) shall be reduced (but not below zero) by any in-
terest expense incurred by any foreign corporation in
the expanded affiliated group to the extent such in-
terest would have been allocated and apportioned to
foreign source income of such corporation if this
subsection were applied to a group consisting of all
the foreign corporations in the expanded affiliated
group. A similar reduction shall be made in the case
of a corporation described in section 1504(b)(4).
‘‘(4) BASIS OF STOCK IN CERTAIN CORPORA-
TIONS ADJUSTED FOR EARNINGS AND PROFITS.—
The basis adjustment rules of subsection (e)(4) shall
be applied only to stock in a corporation which is
not included in the expanded affiliated group and in
which members of the expanded affiliated group own
10 percent or more of the total combined voting
power of all classes of stock entitled to vote.
‘‘(5) EXCEPTION FOR INTEREST EXPENSE OF
CERTAIN DOMESTIC SUBSIDIARIES.—
‘‘(A) IN GENERAL.—A domestic corpora-
tion which is a member of an affiliated group
and which incurs interest expense with respect
to qualified indebtedness (as defined in sub-
paragraph (C)) may elect to allocate and appor-
tion interest expense incurred with respect to
such qualified indebtedness under the rules of
this subsection as if such corporation were the
common parent of an expanded affiliated group
consisting of such domestic corporation and any
corporation at a lower level in the chain of cor-
porations that includes such domestic corpora-
tion.
‘‘(B) EQUALIZATION RULE.—If an election
under subparagraph (A) is made by any mem-
ber of an affiliated group, all interest expense
of such affiliated group not incurred with re-
spect to qualified indebtedness shall be allo-
cated and apportioned to foreign source income
to the extent such expense does not exceed the
amount of all interest expense which, but for
this paragraph, would have been so allocated
and apportioned.
‘‘(C) 
QUALIFIED
INDEBTEDNESS.—For
purposes of this paragraph, qualified indebted-
ness means any borrowing from any unrelated
party which is not guaranteed (or otherwise di-
rectly supported) by any corporation within the
same expanded affiliated group as the borrower
(other than a corporation at a lower level in the
chain of includible corporations). If a borrowing
is not treated as qualified indebtedness solely
because it is guaranteed (or otherwise directly
supported) by another corporation, then—
‘‘(i) such borrowing shall be treated
as the borrowing of such other corporation
if such other corporation is at a higher
level in the chain of includible corporations
than the borrowing corporation, or
‘‘(ii) if such other corporation is in a
different chain of includible corporations,
such borrowing shall be treated as the bor-
rowing of the first common parent of the
borrowing corporation and the guaran-
teeing corporation.
‘‘(D) EFFECT OF CERTAIN TRANSACTIONS
ON QUALIFIED INDEBTEDNESS.—To the extent
that a domestic corporation allocating interest
expense under the rules of subparagraph (A)—
‘‘(i) distributes dividends or makes
other distributions with respect to its stock
in any year to any member of its affiliated
group in excess of the greater of—
‘‘(I) its average annual dividend
(expressed as a percentage of current
earnings and profits) during the 5
taxable year period ending with the
taxable year preceding the taxable
year, or
‘‘(II) 25 percent of its average
annual earnings and profits for such 5
taxable year period, or
‘‘(ii) deals with any related party in
any manner not clearly reflecting the in-
come of the corporation,
an amount of qualified indebtedness equal to
the excess distribution or the understatement or
overstatement of income, as the case may be,
shall be recharacterized for purposes of this
paragraph as nonqualified indebtedness. If a
corporation has not been in existence for 5 tax-
able years, this subparagraph shall be applied
with respect to the period it was in existence.
‘‘(E) EFFECT OF ELECTION ON GROUP.—
If 1 member of an affiliated group makes an
election under subparagraph (A), all members
of such group shall be treated as having made
such election.
‘‘(6) TREATMENT OF CERTAIN FINANCIAL IN-
STITUTIONS.—
‘‘(A) IN GENERAL.—Any corporation that
is predominantly engaged in the active conduct
of a banking, insurance, financing, or similar
business may elect to be treated as a member
of an affiliated or expanded affiliated group
only for purposes of applying this subsection to
corporations so engaged.
‘‘(B) DEFINITION.—A corporation shall be
considered to be predominantly engaged in a
banking, insurance, financing, or similar busi-
ness if at least 80 percent of its gross income
is income described in section 904(d)(2)(C)(ii)
and the regulations thereunder.
‘‘(C) 
EFFECT
OF
CERTAIN
TRANS-
ACTIONS.—Rules similar to the rules of para-
graph (5)(D) shall apply in the case of trans-
actions between a corporation included in the
group described in subparagraph (A) and an-
other member of the affiliated group that is not
included in the group described in subpara-
graph (A).
‘‘(D) EFFECT OF ELECTION ON GROUP.—
If 1 member of an affiliated group makes an
election under subparagraph (A), all members
of such group shall be treated as having made
such election.
‘‘(7) AFFILIATED GROUP.—For purposes of this
subsection—
‘‘(A) AFFILIATED GROUP.—The term ‘af-
filiated group’ has the meaning given by such
term in section 1504(a) (determined without re-
gard to paragraph (2) of section 1504(b)).
‘‘(B) EXPANDED
AFFILIATED
GROUP.—
The term ‘expanded affiliated group’ means an
affiliated group determined without regard to
paragraph (2), (3), or (4) of section 1504(b)
(but does not include a FSC as defined in sec-
tion 922(a)).
‘‘(8) REGULATIONS.—The Secretary shall pre-
scribe regulations providing for the direct allocation
of interest expense in other circumstances where
such allocation would be necessary or appropriate to
carry out the purposes of this subsection.’’
(b) CONFORMING AMENDMENT.—Subsection (e) of
section 864 is amended by striking ‘‘subchapter—’’ and
inserting ‘‘subchapter, except as provided in subsection
(f)—’’.
(c) EFFECTIVE DATE.—The amendments made by
this section shall apply to taxable years ending after De-
cember 31, 1999.
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