Source: https://www.bdo.com/insights/tax/international-tax/treasury-and-irs-issue-guidance-regarding-the-limi
Timestamp: 2019-04-24 12:06:57+00:00

Document:
On November 26, 2018, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued proposed regulations under Section 163(j) (the Proposed Regulations). The Proposed Regulations provide general rules and definitions along with rules for calculating the limitation in consolidated group, partnership, and international contexts.
This tax alert summarizes some of the key international items detailed in the Proposed Regulations (primarily Prop. Reg. §1.163(j)-7 and -8) and the Preamble to the Proposed Regulations. A separate tax alert discussing rules in the Proposed Regulations outside of the international context is forthcoming.
If, for a taxable year, a taxpayer is allowed a deduction under Section 250(a)(1), the taxpayer should take into account the deduction when computing taxable income that is used to calculate ATI, but the Proposed Regulations provide that the taxable income limitation in Section 250(a)(2) does not apply for this purpose. The Preamble notes that taxpayers, however, may be required to make adjustments adding back the Section 250(a)(1) deduction to the extent that some or all of the deduction is attributable to an inclusion under Section 951A.
Treasury states in the Preamble that a separate set of proposed regulations under development will provide general guidance regarding Section 250, including the computation of the Section 250 deduction and the application of the taxable income limitation in Section 250(a)(2).
The Preamble to the Proposed Regulations notes that Treasury has received comments on the interaction of Sections 163(j) and 59A, relating to the tax on the base erosion minimum tax amount. The Proposed Regulations reserve on the interaction of these provisions. The Preamble further provides that comments previously received, as well as any additional comments received, will be further considered in conjunction with separate guidance under Section 59A.
The Proposed Regulations also narrow the scope of foreign corporations that are CFCs for this purpose to those foreign corporations in which at a least one U.S. shareholder owns stock, within the meaning of Section 958(a) (an applicable CFC).
If not all CFC group members have the same taxable year, then, if the election is made, the Proposed Regulations require that all group-level computations be made with respect to a majority U.S. shareholder taxable year.
The Proposed Regulations provide rules concerning the election (referred to as a “CFC group election”), including the requirements for making the CFC group election, the manner for making the CFC group election, and the duration of the CFC group election.
Prop. Reg. §1.163(j)-7(c) provides rules for computing the ATI of an applicable CFC. The principles of Reg. §1.952-2 for determining the CFC’s income and deductions or, for CFCs with ECI, the rules of Section 882, apply for purposes of computing the CFC’s taxable income.
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 the “excess” ATI (referred to in the Proposed Regulations as CFC excess taxable income) of each lower-tier 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 (as defined in Section 163(j)(4)(C)), and, in general, means the amount of a CFC group member’s ATI in excess of the amount needed before there would be disallowed business interest expense. See Prop. Reg. §1.163(j)-7 for rules on computing and “rolling up” CFC excess taxable income among CFC group members for purposes of computing ATI of each of the CFC group members.
To avoid double counting of the taxable income of a CFC already taken into account to determine the CFC’s Section 163(j) limitation, Prop. Reg. §1.163(j)-7(d)(1)(i) provides the general rule (the double counting rule) that the ATI of a U.S. shareholder is computed without regard to any amounts included in gross income under Sections 78, 951(a), and 951A(a) that are properly allocable to a non-excepted trade or business of the U.S. shareholder (each amount, a “specified deemed inclusion” and such amounts, collectively “specified deemed inclusions”) and any deduction allowable under Section 250(a)(1)(B), without regard to the taxable income limitation in Section 250(a)(2), by reason of a specified deemed inclusion (such a deduction, a “specified Section 250 deduction”).
If a U.S. shareholder owns, directly or indirectly through one or more foreign partnerships, stock of a CFC group member that is a specified highest-tier member for which a CFC group election is in effect, and the specified highest-tier member has CFC excess taxable income that is treated as being attributable to taxable income of the CFC group that resulted in the U.S. shareholder having specified income inclusions, the U.S. shareholder may add to its taxable income an amount equal to its proportionate share of the “eligible” CFC excess taxable income of the specified highest-tier member and any other highest-tier members (the addback rule). However, the addition to taxable income under the addback rule is limited to the portion of the specified deemed inclusions, all of which are subtracted from taxable income of any U.S. shareholder under the double-counting rule, that is with respect to CFC group members, reduced by the portion of any specified Section 250 deduction that is allowable by reason of such specified deemed inclusions. The Proposed Regulations refer to the portion described in the preceding sentence as “CFC group inclusions.” Furthermore, the limitation is computed without regard to amounts included in gross income by reason of Section 78 with respect to CFC group members.
Prop. Reg. §1.163(j)-7(d)(2) contains rules in calculating the amount of “eligible” CFC excess taxable income (ETI) of a highest-tier member along with the specified ETI ratio. The Preamble notes that the purpose of the specified ETI ratio is to address the fact that within the CFC group, income of a lower-tier member CFC that is neither subpart F income nor tested income to the extent of GILTI is included in CFC excess taxable income and may be used by an upper-tier CFC group member. The specified ETI ratio is intended to provide an estimate of the portion of CFC excess taxable income attributable to this income.
Prop. Reg. §1.163(j)-7(d)(3) includes rules for when a U.S. shareholder of a CFC group with a CFC group election in effect is a domestic partnership.
Under Prop. Reg. §1.163(j)-7(e), and consistent with the rules in Prop. Reg. §1.163(j)-4(c), the disallowance and carryforward of a deduction for a foreign corporation’s business interest expense does not affect whether and when such business interest expense reduces the corporation’s earnings and profits.
With regards to a nonresident alien individual or a foreign corporation that is not an applicable CFC (a non-CFC FC) that has ECI, the definitions for ATI, business interest expense, business interest income, and floor plan financing interest expense in Prop. Reg. §1.163(j)-1 are modified to limit such amounts to income which is effectively connected income and expenses properly allocable to effectively connected income.
Pursuant to Section 163(j)(8)(B), which permits adjustments to the computation of ATI, a nonresident alien individual or non-CFC FC that is a partner in a partnership that is engaged in a U.S. trade or business modifies the application of the general allocation rules in Prop. Reg. §1.163(j)-6 with respect to excess taxable income, excess business interest expense, and excess business interest income of the partnership to take into account the limitation of such foreign person’s liability for U.S. tax to its ECI. The excess amounts of the partnership, can be used by the nonresident alien individual or non-CFC foreign corporation only to the extent of the partnership’s income that would be effectively connected income with respect to the foreign partner. The amount of excess taxable income and excess business interest expense that can be used by such partner is determined by multiplying the amount of the excess taxable income or the excess business interest allocated under Prop. Reg. §1.163(j)-6 by a ratio equal to the ATI of the partnership, with the adjustments described previously to limit such amount to only effectively connected income or expense items, over the ATI of the partnership determined under Prop. Reg. §1.163(j)-6(d). The amount of excess business interest income that can be used by such partner is limited to ECI business interest income over allocable ECI business interest expense.
The Proposed Regulations coordinate Section 163(j) and Treas. Reg. §1.882-5. The Proposed Regulations require that a foreign corporation that has ECI must first determine its business interest expense allocable to ECI under Reg. §1.882-5 before applying Section 163(j). The foreign corporation then applies Section 163(j) to its business interest expense to determine if any of that business interest expense is disallowed business interest expense. If the foreign corporation is also a partner in a partnership that has ECI, the foreign corporation must back out that portion of the business interest expense determined under Reg. §1.882-5 which is deemed to have come from the partnership as such business interest expense has already been subject to Section 163(j) at the partnership level and the foreign corporation is then left with only the non-partnership business interest expense. If the partnership also had disallowed business interest expense, a portion of the partnership-level interest expense that was backed out of the amount determined under Reg. §1.882-5 will also be disallowed business interest expense. Disallowed business interest expense determined at either the partner-level or partnership level, as appropriate, will not be taken into account for the purpose of determining interest expense under Reg. §1.882-5 in subsequent tax years, but rather will be subject to the limitations of Section 163(j).
As provided in Prop. Reg. §1.163(j)-8(d), an applicable CFC that has ECI must first apply the general rules of Section 163(j) and the Section 163(j) regulations, pursuant to Prop. Reg. §1.163(j)-7(b)(2), to determine how Section 163(j) applies to the applicable CFC. If, after applying Section 163(j) and the Section 163(j) regulations, the applicable CFC has disallowed business interest expense, the applicable CFC then must apportion a part of its disallowed business interest expense to interest expense allocable to effectively connected income as determined under Reg. §1.882-5.
The CFC group election for computing the amount of interest subject to Section 163(j) for a CFC group may be beneficial to taxpayers in most situations, but at the same time, will likely increase the complexity and costs in complying with the Proposed Regulations. BDO can assist clients with understanding and complying with these complex rules.

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