Top 5 Things You Need to Know About The Business Interest Deduction Limitation and Controlled Foreign Corporations

April 28, 2021

At a Glance

  • IRS Final Regulations Update: The IRS released final regulations on the business interest deduction limitation that directly impacts controlled foreign companies (CFCs).
  • Impact on Your Business: The final regulations bring more clarity and potentially bring more challenges for CFCs and their U.S. shareholders.
  • Next Steps: You need to assess your CFC interest deduction strategy, especially in light of COVID-19 relief legislation, to ensure you aren’t leaving money on the table.

Don’t undervalue CFC interest expense tax deductions. Aprio can help you understand the options available to you and develop the best possible strategy for your business.

The full story:

There have been many clarifications and changes to  the new business interest expense deduction limitation rule since the measure was first introduced in the Tax Cuts and Jobs Act of 2017, sometimes creating more confusion than clarity. CFCs and their U.S. shareholders have faced particular uncertainty stemming from somewhat unclear prior proposed regulations.

After reviewing the final regulations released on January 5, 2021, we hope to provide some answers once and for all to U.S. shareholders struggling to navigate the interest deduction disallowance rule as it pertains to CFCs.

Your top 5 questions, answered:

1. What is a CFC group election?

Multinational companies often directly and indirectly own multiple CFCs.  In such an event, it may be more advantageous to make a CFC group election for purposes of the CFC interest deduction limitation. The election allows for a single interest deduction limitation for the entire CFC group rather than each CFC individually. There are specific rules governing when and how to make a CFC group election, so it’s important to work with a tax professional who understands these guidelines and the variables at play.

2. How does a CFC group election impact the CFC deduction limitation calculation?

A CFC group election means you only need to compute a single interest deduction limitation for the entire CFC group. The limitation is calculated using the sum of each CFC group member’s business interest expenses (BIE), business interest income (BII), and adjusted taxable income (ATI). Of course, there are many other factors to this calculation that you should discuss with your tax advisor, but the CFC group election can significantly increase any interest deduction limitation.

3. How are U.S. shareholders of CFCs impacted by the final regulations?

U.S. shareholders subject to an interest deduction limitation would typically exclude foreign income inclusions from ATI, such as subpart F and GILTI; however, the prior proposed regulations allowed U.S. shareholders of certain CFCs to include a portion of that foreign income in their ATI. The final regulations reserved on how to calculate a U.S. shareholder’s ATI with respect to such CFCs, but, for now, shareholders can follow the guidance from the prior proposed regulations while awaiting further study from the Treasury and the IRS.

4. What is the benefit of the safe harbor election?

The safe harbor election attempts to reduce the compliance burden of the interest deduction limitation for  certain standalone CFCs or a CFC group that would not have disallowed BIE deductions by generally using subpart F income and GILTI items in lieu of ATI. However, if the requirements are met and the election is made, it prohibits  CFC inclusions from being included in U.S. shareholder’s ATI.  Therefore, you should weigh the benefits before pursuing the safe harbor.

5. What coordination exists with the CARES Act?

The final regulations coordinate with the CARES Act, which temporarily increased the CFC interest deduction limitation from 30% to 50% of ATI for 2019 and 2020. They also allow the utilization of 2019 ATI instead of 2020 ATI to calculate the 2020 interest deduction limitation. Both provisions were intended to provide assistance in the event of a difficult financial year.

The bottom line

The recent final regulations provided much-needed clarity, but the interest deduction limitation rule is still highly complex – especially for CFCs and their U.S. shareholders. With so many variables at play, you have an opportunity to model the implications of making a CFC group election to determine whether it may result in a greater amount of interest deductibility. Aprio can help with this critical strategic decision.

Aprio’s international tax professionals are deeply experienced in tax regulation nuances, and we’re constantly monitoring the latest IRS guidance. We can help you understand the options available and formulate the best approach for you and your business.

Related Resources:

Trying to navigate complex IRS regulations on your own could mean undervaluing potential interest expense tax deductions or, worse, risking non-compliance. Contact our team today to start assessing your business interest deduction strategy.

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About the Author

Yelena Epova

Yelena is the partner-in-charge of Aprio’s International Services practice. She specializes in advising domestic and international companies on international tax issues and tax planning strategies regarding inbound and outbound operations. She also assists clients with domestic tax issues by providing tax planning and compliance services.

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