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The U.S. tax reform legislation (the Act) enacted in late 2017 made important changes that affect financing of U.S. operations of companies not headquartered in the United States. Among the most significant of these changes are the new Section 163(j) limitations on interest expense deductions and the new Section 267A anti-hybrid rules. Now that taxpayers and practitioners have had an opportunity to digest the impact of these changes, this is an excellent time to take a closer look at these provisions, especially with the IRS having published pertinent regulations and other guidance, with more expected in the near future.
The interest expense deduction limitations found in Section 163(j) apply to all taxpayers operating in the United States with respect to both related-party and third-party debt. Section 163(j) limits a taxpayer's U.S. business interest expense deduction to the sum of the taxpayer's business interest income; 30% of the taxpayer's 'adjusted taxable income' (roughly equivalent to earnings before interest, tax, depreciation, and amortization, or EBITDA, through 2022 and to EBIT thereafter); and the taxpayer's floor plan financing interest for the tax year.
Observation: These rules bring the U.S. approach to interest deduction limitations more in line with the OECD approach.
Section 267A denies a deduction for interest (and royalty) payments paid or accrued by a U.S. corporation to a related 'foreign' party pursuant to a 'hybrid transaction' or made by or to a 'hybrid entity' if (i) there is no income inclusion by the 'foreign' related party for 'foreign' purposes (based on country of residence), or (ii) the related party is allowed a deduction for 'foreign' purposes. Under proposed regulations that may be finalized with a retroactive effective date, certain other types of hybrid arrangements also may result in denied deductions.
Observation: These rules generally are intended to be consistent with the BEPS anti-hybrid approach.
Non-U.S. companies also need to analyze the possible impact of the new base erosion and anti-abuse tax (BEAT), as well as the regulations under Section 385, which authorizes the U.S. Treasury to prescribe rules to determine whether an interest in a corporation is treated for purposes of the Code as stock or indebtedness (or as in part stock and in part indebtedness) by setting forth factors to be taken into account with...