Limitation on Deduction for Business Interest Expense; Allocation of Interest Expense by Passthrough Entities; Dividends Paid by Regulated Investment Companies; Application of Limitation on Deduction for Business Interest Expense to United States Shareholders of Controlled Foreign Corporations and to Foreign Persons With Effectively Connected Income

 
CONTENT
56846
Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Proposed Rules
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG–107911–18]
RIN 1545–BP73
Limitation on Deduction for Business
Interest Expense; Allocation of Interest
Expense by Passthrough Entities;
Dividends Paid by Regulated
Investment Companies; Application of
Limitation on Deduction for Business
Interest Expense to United States
Shareholders of Controlled Foreign
Corporations and to Foreign Persons
With Effectively Connected Income
AGENCY
: Internal Revenue Service (IRS),
Treasury.
ACTION
: Notice of proposed rulemaking.
SUMMARY
: This notice of proposed
rulemaking provides rules concerning
the limitation on the deduction for
business interest expense after
amendment of the Internal Revenue
Code (Code) by the provisions
commonly known as the Tax Cuts and
Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus
Aid, Relief, and Economic Security Act,
which was enacted on March 27, 2020.
Specifically, these proposed regulations
address application of the limitation in
contexts involving passthrough entities,
regulated investment companies (RICs),
United States shareholders of controlled
foreign corporations, and foreign
persons with effectively connected
income in the United States. These
proposed regulations also provide
guidance regarding the definitions of
real property development, real
property redevelopment, and a
syndicate. These proposed regulations
affect taxpayers that have business
interest expense, particularly
passthrough entities, their partners and
shareholders, as well as foreign
corporations and their United States
shareholders and foreign persons with
effectively connected income. These
proposed regulations also affect RICs
that have business interest income, RIC
shareholders that have business interest
expense, and members of a consolidated
group.
DATES
: Written or electronic comments
and requests for a public hearing must
be received by November 2, 2020, which
is 60 days after the date of filing for
public inspection with the Office of the
Federal Register.
ADDRESSES
: Commenters are strongly
encouraged to submit public comments
electronically. Submit electronic
submissions via the Federal
eRulemaking Portal at
www.regulations.gov (indicate IRS and
REG–107911–18) by following the
online instructions for submitting
comments. Once submitted to the
Federal eRulemaking Portal, comments
cannot be edited or withdrawn. The IRS
expects to have limited personnel
available to process public comments
that are submitted on paper through
mail. The Department of the Treasury
(Treasury Department) and the IRS will
publish for public availability any
comment submitted electronically, and
when practicable on paper, to its public
docket.
Send paper submissions to:
CC:PA:LPD:PR (REG–107911–18), Room
5203, Internal Revenue Service, P.O.
Box 7604, Ben Franklin Station,
Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT
:
Concerning § 1.163(j)–1, Steven
Harrison, (202) 317–6842, Michael Chin,
(202) 317–6842 or John Lovelace, (202)
317–5363; concerning § 1.163(j)–2,
Sophia Wang, (202) 317–4890 or John
Lovelace, (202) 317–5363, concerning
§ 1.163–14, §1.163(j)–6, or § 1.469–9,
William Kostak, (202) 317–5279 or
Anthony McQuillen, (202) 317–5027;
concerning § 1.163–15, Sophia Wang,
(202) 317–4890; concerning § 1.163(j)–7
or § 1.163(j)–8, Azeka J. Abramoff, (202)
317–3800 or Raphael J. Cohen, (202)
317–6938, concerning § 1.1256(e)–2,
Sophia Wang, (202) 317–4890 or Pamela
Lew, (202) 317–7053; concerning
submissions of comments and/or
requests for a public hearing, Regina L.
Johnson, (202) 317–5177 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION
:
Background
This document contains proposed
amendments to the Income Tax
Regulations (26 CFR part 1) under
sections 163 (in particular section
163(j)), 469 and 1256(e) of the Code.
Section 163(j) was amended as part of
Public Law 115–97, 131 Stat. 2054
(December 22, 2017), commonly
referred to as the Tax Cuts and Jobs Act
(TCJA), and the Coronavirus Aid, Relief,
and Economic Security Act, Public Law
116–136 (2020) (CARES Act). Section
13301(a) of the TCJA amended section
163(j) by removing prior section
163(j)(1) through (9) and adding section
163(j)(1) through (10). The provisions of
section 163(j) as amended by section
13301 of the TCJA are effective for tax
years beginning after December 31,
2017. The CARES Act further amended
section 163(j) by redesignating section
163(j)(10), as amended by the TCJA, as
new section 163(j)(11), and adding a
new section 163(j)(10) providing special
rules for applying section 163(j) to
taxable years beginning in 2019 or 2020.
Section 163(j) generally limits the
amount of business interest expense
(BIE) that can be deducted in the current
taxable year (also referred to in this
Preamble as the current year). Under
section 163(j)(1), the amount allowed as
a deduction for BIE is limited to the sum
of (1) the taxpayer’s business interest
income (BII) for the taxable year; (2) 30
percent of the taxpayer’s adjusted
taxable income (ATI) for the taxable
year (30 percent ATI limitation); and (3)
the taxpayer’s floor plan financing
interest expense for the taxable year (in
sum, the section 163(j) limitation). As
further described later in this
Background section, section 163(j)(10),
as amended by the CARES Act, provides
special rules relating to the ATI
limitation for taxable years beginning in
2019 or 2020. Under section 163(j)(2),
the amount of any BIE that is not
allowed as a deduction in a taxable year
due to the section 163(j) limitation is
treated as business interest paid in the
succeeding taxable year.
The section 163(j) limitation applies
to all taxpayers, except for certain small
businesses that meet the gross receipts
test in section 448(c) and certain trades
or businesses listed in section 163(j)(7).
Section 163(j)(3) provides that the
section 163(j) limitation does not apply
to any taxpayer that meets the gross
receipts test under section 448(c), other
than a tax shelter prohibited from using
the cash receipts and disbursements
method of accounting under section
448(a)(3).
Section 163(j)(4) provides special
rules for applying section 163(j) in the
case of passthrough entities. Section
163(j)(4)(A) requires that the section
163(j) limitation be applied at the
partnership level, and that a partner’s
ATI be increased by the partner’s share
of excess taxable income, as defined in
section 163(j)(4)(C), but not by the
partner’s distributive share of income,
gain, deduction, or loss. Section
163(j)(4)(B) provides that the amount of
partnership BIE limited by section
163(j)(1) (EBIE) is carried forward at the
partner level. Section 163(j)(4)(B)(ii)
provides that EBIE allocated to a partner
and carried forward is available to be
deducted in a subsequent year only to
the extent that the partnership allocates
excess taxable income to the partner. As
further described later in this
Background section, section 163(j)(10),
as amended by the CARES Act, provides
a special rule for excess business
interest expense allocated to a partner in
a taxable year beginning in 2019.
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Section 163(j)(4)(B)(iii) provides rules
for the adjusted basis in a partnership of
a partner that is allocated EBIE. Section
163(j)(4)(D) provides that rules similar
to the rules of section 163(j)(4)(A) and
(C) apply to S corporations and S
corporation shareholders.
Section 163(j)(5) and (6) define
‘‘business interest’’ and ‘‘business
interest income,’’ respectively, for
purposes of section 163(j). Generally,
these terms include interest expense
and interest includible in gross income
that is properly allocable to a trade or
business (as defined in section 163(j)(7))
and do not include investment income
or investment expense within the
meaning of section 163(d). The
legislative history states that ‘‘a
corporation has neither investment
interest nor investment income within
the meaning of section 163(d). Thus,
interest income and interest expense of
a corporation is properly allocable to a
trade or business, unless such trade or
business is otherwise explicitly
excluded from the application of the
provision.’’ H. Rept. 115–466, at 386, fn.
688 (2017).
Under section 163(j)(7), the limitation
on the deduction for business interest
expense in section 163(j)(1) does not
apply to certain trades or businesses
(excepted trades or businesses). The
excepted trades or businesses are the
trade or business of providing services
as an employee, electing real property
businesses, electing farming businesses,
and certain regulated utility businesses.
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer without
regard to the following: Items not
properly allocable to a trade or business;
business interest and business interest
income; net operating loss (NOL)
deductions; and deductions for
qualified business income under section
199A. ATI also generally excludes
deductions for depreciation,
amortization, and depletion with
respect to taxable years beginning before
January 1, 2022, and it includes other
adjustments provided by the Secretary
of the Treasury.
Section 163(j)(9) defines ‘‘floor plan
financing interest’’ as interest paid or
accrued on ‘‘floor plan financing
indebtedness.’’ These provisions allow
taxpayers incurring interest expense for
the purpose of securing an inventory of
motor vehicles held for sale or lease to
deduct the full expense without regard
to the section 163(j) limitation.
Under section 163(j)(10)(A)(i), the
amount of business interest that is
deductible under section 163(j)(1) for
taxable years beginning in 2019 or 2020
is computed using 50 percent, rather
than 30 percent, of the taxpayer’s ATI
for the taxable year (50 percent ATI
limitation). A taxpayer may elect not to
apply the 50 percent ATI limitation to
any taxable year beginning in 2019 or
2020, and instead apply the 30 percent
ATI limitation. This election must be
made separately for each taxable year.
Once the taxpayer makes the election,
the election may not be revoked without
the consent of the Secretary of the
Treasury or his delegate. See section
163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and
163(j)(10)(A)(iii) provide that, in the
case of a partnership, the 50 percent ATI
limitation does not apply to
partnerships for taxable years beginning
in 2019, and the election to not apply
the 50 percent ATI limitation may be
made only for taxable years beginning in
2020, and may be made only by the
partnership. Under section
163(j)(10)(A)(ii)(II), however, a partner
treats 50 percent of its allocable share of
a partnership’s excess business interest
expense for 2019 as a business interest
expense in the partner’s first taxable
year beginning in 2020 that is not
subject to the section 163(j) limitation
(50 percent EBIE rule). The remaining
50 percent of the partner’s allocable
share of the partnership’s excess
business interest expense remains
subject to the section 163(j) limitation
applicable to excess business interest
expense carried forward at the partner
level. A partner may elect out of the 50
percent EBIE rule.
Section 163(j)(10)(B)(i) allows a
taxpayer to elect to substitute its ATI for
the last taxable year beginning in 2019
(2019 ATI) for the taxpayer’s ATI for a
taxable year beginning in 2020 (2020
ATI) in determining the taxpayer’s
section 163(j) limitation for the taxable
year beginning in 2020.
Section 163(j)(11) provides cross-
references to provisions requiring that
electing farming businesses and electing
real property businesses excepted from
the section 163(j) limitation use the
alternative depreciation system (ADS),
rather than the general depreciation
system, for certain types of property.
The required use of ADS results in the
inability of these electing trades or
businesses to use the additional first-
year depreciation deduction under
section 168(k) for those types of
property.
On December 28, 2018, the
Department of the Treasury (Treasury
Department) and the IRS (1) published
proposed regulations under section
163(j), as amended by the TCJA, in a
notice of proposed rulemaking (REG–
106089–18) (2018 Proposed
Regulations) in the Federal Register (83
FR 67490), and (2) withdrew the notice
of proposed rulemaking (1991–2 C.B.
1040) published in the Federal Register
on June 18, 1991 (56 FR 27907 as
corrected by 56 FR 40285 (August 14,
1991)) to implement rules under section
163(j) before amendment by the TCJA.
The 2018 Proposed Regulations were
issued following guidance announcing
and describing regulations intended to
be issued under section 163(j). See
Notice 2018–28, 2018–16 I.R.B. 492
(April 16, 2018).
A public hearing on the 2018
Proposed Regulations was held on
February 27, 2019. The Treasury
Department and the IRS also received
written comments responding to the
2018 Proposed Regulations (available at
http://www.regulations.gov). In response
to certain comments, the Treasury
Department and the IRS are publishing
this notice of proposed rulemaking to
provide additional proposed regulations
(these Proposed Regulations) under
section 163(j).
Concurrently with the publication of
these Proposed Regulations, the
Treasury Department and the IRS are
publishing in the Rules and Regulations
section of this edition of the Federal
Register (RIN 1545–BO73) final
regulations under section 163(j) (the
Final Regulations).
On April 10, 2020, the Treasury
Department and the IRS released
Revenue Procedure 2020–22, 2020–18
I.R.B. 745, to provide the time and
manner of making a late election, or
withdrawing an election, under section
163(j)(7)(B) to be an electing real
property trade or business or section
163(j)(7)(C) to be an electing farming
business for taxable years beginning in
2018, 2019, or 2020. Revenue Procedure
2020–22 also provides the time and
manner of making or revoking elections
provided by the CARES Act under
section 163(j)(10) for taxable years
beginning in 2019 or 2020. As described
earlier in this Background section, these
elections are: (1) To not apply the 50
percent ATI limitation under section
163(j)(10)(A)(iii); (2) to use the
taxpayer’s 2019 ATI to calculate the
taxpayer’s section 163(j) limitation for
any taxable year beginning in 2020
under section 163(j)(10)(B); and (3) for
a partner to elect out of the 50 percent
EBIE rule under section
163(j)(10)(A)(ii)(II).
Explanation of Provisions
These Proposed Regulations would
provide guidance in addition to the
Final Regulations regarding the section
163(j) limitation. These Proposed
Regulations would also add or amend
regulations under certain other
provisions of the Code where necessary
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to provide conformity across the Income
Tax Regulations. A significant number
of the terms used throughout these
Proposed Regulations are defined in
§ 1.163(j)–1 of the Final Regulations and
discussed in the Explanation of
Provisions section of the 2018 Proposed
Regulations and the Summary of
Comments and Explanation of Revisions
section of the Final Regulations. Some
of these terms are further discussed in
this Explanation of Provisions section as
they relate to specific provisions of
these Proposed Regulations.
Part I of this Explanation of
Provisions describes proposed rules that
would allocate interest expense for
purposes of sections 469, 163(d), 163(h),
and 163(j) in connection with certain
transactions involving passthrough
entities. Part II provides proposed rules
relating to distributions of debt proceeds
from any taxpayer account or from cash
so that interest expense may be
allocated for purposes of sections 469,
163(d), 163(h), and 163(j). Part III
describes proposed modifications to the
definitions and general guidance in
§ 1.163(j)–1, including proposed rules
permitting taxpayers to apply a different
computational method in determining
adjustments to tentative taxable income
to address sales or other dispositions of
depreciable property, stock of a
consolidated group member, or interests
in a partnership, and proposed rules
allowing RIC shareholders to treat
certain RIC dividends as interest income
for purposes of section 163(j). Part IV
describes proposed modifications to
§ 1.163(j)–6, relating to the applicability
of the section 163(j) limitation to
passthrough entities, including
proposed rules on the applicability of
the section 163(j) limitation to trading
partnerships and publicly traded
partnerships, the application of the
section 163(j) limitation in partnership
self-charged lending transactions,
proposed rules relating to the treatment
of excess business interest expense in
tiered partnerships, proposed rules
relating to partnership basis adjustments
upon partner dispositions, proposed
rules regarding the election to substitute
2019 ATI for the partnership’s 2020 ATI
in determining the partnership’s section
163(j) limitation for a taxable year
beginning in 2020, and proposed rules
regarding excess business interest
expense allocated to a partner in a
taxable year beginning in 2019.
Part V discusses re-proposed rules
regarding the application of the section
163(j) limitation to foreign corporations
and United States shareholders (as
defined in section 951(b) (U.S.
shareholders) of controlled foreign
corporations (as defined in section
957(a)) (CFCs). Part VI discusses re-
proposed rules regarding the application
of the section 163(j) limitation to
nonresident alien individuals and
foreign corporations with effectively
connected income in the United States.
Part VII describes proposed
modifications to the definition of a real
property trade or business under
§ 1.469–9 for purposes of the passive
activity loss rules and the definition of
an electing real property trade or
business under section 163(j)(7)(B). Part
VIII describes proposed rules regarding
the definition of a ‘‘tax shelter’’ for
purposes of § 1.163(j)–2 and section
1256(e), as well as proposed rules
regarding the election to use 2019 ATI
in determining the taxpayer’s section
163(j) limitation for a taxable year
beginning in 2020. Part IX describes
proposed modifications regarding the
application of the corporate look-
through rules to tiered structures.
I. Proposed § 1.163–14: Allocation of
Interest Expense With Respect to
Passthrough Entities
Section 1.163–8T provides rules
regarding the allocation of interest
expense for purposes of applying the
passive activity loss limitation in
section 469, the investment interest
limitation in section 163(d), and the
personal interest limitation in section
163(h) (such purposes, collectively,
§ 1.163–8T purposes). Under §1.163–
8T, debt generally is allocated by tracing
disbursements of the debt proceeds to
specific expenditures and interest
expense associated with debt is
allocated for § 1.163–8T purposes in the
same manner as the debt to which such
interest expense relates. When debt
proceeds are deposited to the borrower’s
account, and the account also contains
unborrowed funds, § 1.163–8T(c)
provides that the debt generally is
allocated to expenditures by treating
subsequent expenditures from the
account as made first from the debt
proceeds to the extent thereof. The rules
further provide that if the proceeds of
two or more debts are deposited in the
account, the proceeds are treated as
expended in the order in which they
were deposited. In addition to these
rules, § 1.163–8T also provides specific
rules to address reallocation of debt,
repayments and refinancing.
The preamble to § 1.163–8T (52 FR
24996) stated that ‘‘interest expense of
partnerships and S corporations, and of
partners and S corporation
shareholders, is generally allocated in
the same manner as the interest expense
of other taxpayers.’’ The preamble
acknowledged the need for special rules
for debt financed distributions to
owners of partnerships and S
corporations, and for cases in which
taxpayers incur debt to acquire or
increase their capital interest in the
passthrough entity, but reserved on
these issues and requested comments.
In a series of notices, the Treasury
Department and the IRS provided
further guidance with respect to the
allocation of interest expense in
connection with certain transactions
involving passthrough entities and
owners of passthrough entities. See
Notice 88–20, 1988–1 C.B. 487, Notice
88–37, 1988–1 C.B. 522, and Notice 89–
35, 1989–1 C.B. 675. Specifically, Notice
89–35 provides, in part, rules
addressing the treatment of (1) a
passthrough entity owner’s debt
allocated to contributions to, or
purchases of, interests in a passthrough
entity (debt-financed contributions or
acquisitions), and (2) passthrough entity
debt allocated to distributions by the
entity to its owners (debt-financed
distributions).
In the case of a debt-financed
acquisition of an interest in a
passthrough entity by purchase (rather
than by way of a contribution to the
capital of the entity), Notice 89–35
provides that the interest expense of the
owner of the passthrough entity, for
§ 1.163–8T purposes, is allocated among
the assets of the entity using any
reasonable method. A reasonable
method for this purpose includes, for
example, allocating the debt among all
of the assets of the passthrough entity
based on the fair market value, the book
value, or the adjusted basis of the assets,
reduced by the amount of any debt of
the entity or the amount of any debt that
the owner of the entity allocates to such
assets. Notice 89–35 also provides that
interest expense on debt proceeds
allocated to a contribution to the capital
of a passthrough entity shall be
allocated using any reasonable method
for § 1.163–8T purposes. For this
purpose, any reasonable method
includes allocating the debt among the
assets of the passthrough entity or
tracing the debt proceeds to the
expenditures of the passthrough entity.
In the case of debt-financed
distributions, Notice 89–35 provides a
general allocation rule and an optional
allocation rule. The general allocation
rule applies the principles of § 1.163–8T
to interest expense associated with debt-
financed distributions by applying a
tracing approach to determine the
character of the interest expense for
§ 1.163–8T purposes. Under this
approach, the debt proceeds and the
associated interest expense related to a
debt-financed distribution are allocated
under § 1.163–8T in accordance with
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the use of the distributed debt proceeds
by the distributee owner of the
passthrough entity. To the extent an
owner’s share of a passthrough entity’s
interest expense related to the debt-
financed distribution exceeds the
entity’s interest expense on the portion
of the debt proceeds distributed to that
particular owner, Notice 89–35 provides
that the passthrough entity may allocate
such excess interest expense using any
reasonable method.
The optional allocation rule
applicable to debt-financed
distributions allows a passthrough
entity to allocate distributed debt
proceeds and the associated interest
expense to one or more expenditures,
other than distributions, of the entity
that are made during the same taxable
year of the entity as the distribution, to
the extent that debt proceeds, including
other distributed debt proceeds, are not
otherwise allocated to such
expenditures. Under the optional
allocation rule, distributed debt
proceeds are traced to the owner’s use
of the borrowed funds to the extent that
such distributed debt proceeds exceed
the entity’s expenditures, not including
distributions, for the taxable year to
which debt proceeds are not otherwise
allocated.
While the 2018 Proposed Regulations
did not include rules to further address
the application of § 1.163–8T to
passthrough entities, the Treasury
Department and the IRS received
comments indicating that, for purposes
of section 163(j), a tracing rule based on
how a passthrough entity owner uses
the proceeds of a debt-financed
distribution does not align well with the
statutory mandate in section 163(j)(4) to
apply section 163(j) at the passthrough
entity level. Based on these comments
and a review of the rules under § 1.163–
8T, the Treasury Department and the
IRS have determined that additional
rules, specific to passthrough entities
and their owners, are needed to clarify
how the rules under § 1.163–8T work
when applied to a passthrough entity
and to account for the entity-level
limitation under section 163(j)(4).
A. In General
The rules of § 1.163–8T generally
apply to partnerships, S corporations,
and their owners and the rules in
proposed § 1.163–14 would provide
additional rules for purposes of
applying the § 1.163–8T rules to
passthrough entities. As with the rules
under § 1.163–8T, proposed §1.163–14
would provide that interest expense on
a debt incurred by a passthrough entity
is allocated in the same manner as the
debt to which such interest relates is
allocated, and that debt is generally
allocated by tracing disbursements of
the debt proceeds to specific
expenditures.
The Treasury Department and the IRS
have determined that the scope of
§ 1.163–8T(a)(4) and (b) is not
appropriate in the passthrough entity
context. Section 1.163–8T(a)(4)
generally provides rules regarding the
treatment of interest expense allocated
to specific expenditures, which are
described in § 1.163–8T(b). However,
the list of expenditures described in
§ 1.163–8T(b) is based on an allocation
of interest for purposes of applying
sections 163(d), 163(h), and 469, and
does not adequately account for the uses
of debt proceeds by a passthrough entity
(for example, distributions to owners).
To more accurately account for the
types of expenditures made by
passthrough entities, proposed § 1.163–
14(b) would provide rules tailored to
passthrough entities. In addition, the
framework that proposed § 1.163–14(b)
would provide is needed for a
passthrough entity to determine how
much of its interest expense is allocable
to a trade or business for purposes of
applying section 163(j). These proposed
regulations would apply before a
passthrough entity applies any of the
rules in section 163(j) (including
§ 1.163(j)–10).
In application, a passthrough entity
would continue to apply the operative
rules in § 1.163–8T to allocate debt and
the interest expense associated with
such debt. However, instead of generally
tracing debt proceeds to the types of
expenditures described under § 1.163–
8T(b) and treating any interest expense
associated with such debt proceeds in
the manner described under § 1.163–
8T(a)(4), a passthrough entity would
generally trace debt proceeds to the
types of expenditures described under
proposed § 1.163–14(b)(2) and treat any
interest expense associated with such
debt proceeds in the manner provided
under proposed § 1.163–14(b)(1).
B. Debt Financed Distributions
Proposed § 1.163–14 would provide
that when debt proceeds of a
passthrough entity are allocated under
§ 1.163–8T to distributions to owners of
the entity, the debt proceeds distributed
to any owner and the associated interest
expense shall be allocated under
proposed § 1.163–14(d). In general,
proposed § 1.163–14(d) would adopt a
rule similar to Notice 89–35, but with
the following modifications. First,
instead of providing that passthrough
entities may use the optional allocation
rule, proposed § 1.163–14(d) would
generally provide that passthrough
entities are required to apply a rule that
is similar to the optional allocation rule.
Second, instead of providing that the
passthrough entity may allocate excess
interest expense using any reasonable
method, proposed § 1.163–14(d) would
generally provide that the passthrough
entity must allocate excess interest
expense based on the adjusted tax basis
of the passthrough entity’s assets.
Specifically, proposed § 1.163–
14(d)(1) would provide a rule based in
principle on the optional allocation rule
in Notice 89–35. Under this proposed
rule, distributed debt proceeds (debt
proceeds of a passthrough entity
allocated under § 1.163–8T to
distributions to owners of the entity)
would first be allocated under proposed
§ 1.163–14(d)(1)(i) to the passthrough
entity’s available expenditures.
Available expenditures are those
expenditures of a passthrough entity
made in the same taxable year as the
distribution, but only to the extent that
debt proceeds (including other
distributed debt proceeds) are not
otherwise allocated to such expenditure.
This approach is consistent with the
concept that money is fungible (a
passthrough entity may be fairly treated
as distributing non-debt proceeds rather
than debt proceeds and using debt
proceeds rather than non-debt proceeds
to finance its non-distribution
expenditures) and seeks to coordinate
the interest allocation rules with the
entity-level approach to passthroughs
adopted in section 163(j). Where the
distributed debt proceeds exceed the
passthrough entity’s available
expenditures, this excess amount of
distributed debt proceeds would be
allocated to distributions to owners of
the passthrough entity (debt financed
distributions) under proposed § 1.163–
14(d)(1)(ii).
After determining the amount of its
distributed debt proceeds allocated to
available expenditures and debt
financed distributions, a passthrough
entity would use this information to
determine the tax treatment of each
owner’s allocable interest expense (that
is, an owner’s share of interest expense
associated with the distributed debt
proceeds allocated under section 704(b)
or 1366(a)). To aid the passthrough
entity and owner in determining the tax
treatment of each owner’s allocable
interest expense, proposed § 1.163–
14(d)(2) would provide rules for
determining the portion of each owner’s
allocable interest expense that is (1)
debt financed distribution interest
expense, (2) expenditure interest
expense, and (3) excess interest
expense. These three categories of
allocable interest expense are mutually
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exclusive—e.g., a given dollar of
allocable interest expense cannot
simultaneously be both debt financed
distribution interest expense and
expenditure interest expense. The
computations in proposed § 1.163–
14(d)(2) would ensure this outcome.
Once a passthrough entity categorizes
each owner’s allocable interest expense
as described earlier, it would apply
proposed § 1.163–14(d)(3) to determine
the tax treatment of such interest
expense. The manner in which the tax
treatment of allocable interest expense
is determined depends on how such
allocable interest expense was
categorized under proposed § 1.163–
14(d)(2).
Conceptually, each of the three
categories described earlier, as well as
the prescribed tax treatment of interest
expense in each category, is discussed
in Notice 89–35. Debt financed
distribution interest expense is referred
to in Notice 89–35 as an owner’s share
of a passthrough entity’s interest
expense on debt proceeds allocated to
such owner. Similar to Notice 89–35,
proposed § 1.163–14(d)(3)(i) would
generally provide that such interest
expense is allocated under § 1.163–8T
in accordance with the owner’s use of
the debt proceeds. Further, expenditure
interest expense is referred to in Notice
89–35 as interest expense allocated
under the optional allocation rule.
Similar to Notice 89–35, proposed
§ 1.163–14(d)(3)(ii) would generally
provide that the tax treatment of such
interest expense is determined based on
how the distributed debt proceeds were
allocated among available expenditures.
Finally, both Notice 89–35 and
proposed § 1.163–14(d) would use the
term excess interest expense to refer to
an owner’s share of allocable interest
expense in excess of the entity’s interest
expense on the portion of the debt
proceeds distributed to that particular
owner. Unlike Notice 89–35, which
generally allows any reasonable method
for determining the tax treatment of
excess interest expense, proposed
§ 1.163–14(d)(3)(iii) would generally
provide that the tax treatment of excess
interest expense is determined by
allocating the distributed debt proceeds
among all the assets of the passthrough
entity, pro-rata, based on the adjusted
basis of such assets.
Proposed § 1.163–14(d)(4) also would
provide rules addressing the tax
treatment of the interest expense of a
transferee owner where the transferor
had previously been allocated debt
financed distribution interest expense.
In the case of a transfer of an interest in
a passthrough entity, any debt financed
distribution interest expense of the
transferor generally shall be treated as
excess interest expense by the
transferee. However, in the case of a
transfer of an interest in a passthrough
entity to a person who is related to the
transferor, any debt financed
distribution interest expense of the
transferor shall continue to be treated as
debt financed distribution interest
expense by the related party transferee,
and the tax treatment of such debt
financed distribution expense shall be
the same to the related party transferee
as it was to the transferor. The term
related party means any person who
bears a relationship to the taxpayer
which is described in section 267(b) or
707(b)(1).
The proposed regulations also would
include an anti-avoidance rule to
recharacterize arrangements entered
into with a principal purpose of
avoiding the rules of proposed § 1.163–
14(d), including the transfer of an
interest in a passthrough entity by an
owner who treated a portion of its
allocable interest expense as debt
financed distribution interest expense to
an unrelated party pursuant to a plan to
transfer the interest back to the owner
who received the debt financed
distribution interest expense or to a
party who is related to the owner who
received the debt financed distribution
interest expense.
C. Operational Rules
Proposed § 1.163–14 also would
include several operational rules that
clarify the application of certain rules
under § 1.163–8T as they apply to
passthrough entities. Proposed § 1.163–
14(e) would provide an ordering rule
applicable to repayment of debt by
passthrough entities similar to the rules
in § 1.163–8T(d)(1). Proposed §1.163–
14(g) would provide that any transfer of
an ownership interest in a passthrough
entity is not a reallocation event for
purposes of § 1.163–8T(j), except as
provided for in § 1.163–14(d)(4).
D. Debt-Financed Acquisitions
Proposed § 1.163–14(f) would adopt a
rule providing that the tax treatment of
an owner’s interest expense associated
with a debt financed acquisition (either
by purchase or contribution) will be
determined by allocating the debt
proceeds among the assets of the entity.
The owner would allocate the debt
proceeds (1) in proportion to the relative
adjusted tax basis of the entity’s assets
reduced by any debt allocated to such
assets, or (2) based on the adjusted basis
of the entity’s assets in accordance with
the rules in § 1.163(j)–10(c)(5)(i)
reduced by any debt allocated to such
assets. The Treasury Department and
the IRS request comments regarding
whether asset basis (either adjusted tax
basis or adjusted tax basis based on the
rules in § 1.163(j)–10(c)(5)(i)) less the
amount of debt allocated to assets under
§§ 1.163–14 and 1.163–8T is appropriate
as the sole method for allocating interest
expense in this context.
II. Proposed § 1.163–15: Debt Proceeds
Distributed From Any Taxpayer
Account or From Cash
Proposed § 1.163–15 supplements the
rules in § 1.163–8T regarding debt
proceeds distributed from any taxpayer
account or from cash proceeds. Section
1.163–8T(c)(4)(iii)(B) provides that a
taxpayer may treat any expenditure
made from an account within 15 days
after the debt proceeds are deposited in
such account as being made from such
proceeds, regardless of any other rules
in § 1.163–8T(c)(4). Under §1.163–
8T(c)(5)(i), if a taxpayer receives debt
proceeds in cash, the taxpayer may treat
any cash expenditure made within 15
days after receiving the cash as being
made from such debt proceeds, and may
treat such expenditure as being made on
the date the taxpayer received the cash.
Commenters have suggested that the 15-
day limit in § 1.163–8T could encourage
taxpayers to keep separate accounts,
rather than commingled accounts for
tracing purposes.
In Notice 88–20, 1988–1 C.B. 487, the
IRS announced the intention to issue
regulations providing that, for debt
proceeds deposited in an account on or
before December 31, 1987, taxpayers
could treat any expenditure made from
any account of the taxpayer or from cash
within 30 days before or after debt
proceeds are deposited in such account
or any other account of the taxpayer as
made from such proceeds. The Notice
states that the regulations also would
provide that for debt proceeds received
in cash on or before December 31, 1987,
taxpayers may treat any expenditure
made from any account of the taxpayer
or from cash within 30 days before or
after debt proceeds are received in cash
as made from such proceeds. Section VI
of Notice 89–35 adopts the standard
described in Notice 88–20 without the
date limitation, although no regulations
have been issued.
Consistent with Notice 89–35,
proposed § 1.163–15 provides that
taxpayers may treat any expenditure
made from an account of the taxpayer or
from cash within 30 days before or after
debt proceeds are deposited in any
account of the taxpayer or received in
cash as made from such proceeds.
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III. Proposed Modifications to
§ 1.163(j)–1(b): Definitions
A. Adjustments to Tentative Taxable
Income
Section 1.163(j)–1(b)(1) requires
taxpayers to make certain adjustments
to tentative taxable income in
computing ATI, including adjustments
to address certain sales or other
dispositions of depreciable property,
stock of a consolidated group member
(member stock), or interests in a
partnership. More specifically,
§ 1.163(j)–1(b)(1)(ii)(C) provides that, if
property is sold or otherwise disposed
of, the greater of the allowed or
allowable depreciation, amortization, or
depletion of the property for the
taxpayer (or, if the taxpayer is a member
of a consolidated group, the
consolidated group) for taxable years
beginning after December 31, 2017, and
before January 1, 2022 (such years, the
EBITDA period), with respect to such
property is subtracted from tentative
taxable income. Section 1.163(j)–
1(b)(1)(ii)(D) provides that, with respect
to the sale or other disposition of stock
of a member of a consolidated group by
another member, the investment
adjustments under § 1.1502–32 with
respect to such stock that are
attributable to deductions described in
§ 1.163(j)–1(b)(1)(ii)(C) are subtracted
from tentative taxable income. Section
1.163(j)–1(b)(1)(ii)(E) provides that, with
respect to the sale or other disposition
of an interest in a partnership, the
taxpayer’s distributive share of
deductions described in § 1.163(j)–
1(b)(1)(ii)(C) with respect to property
held by the partnership at the time of
such sale or other disposition is
subtracted from tentative taxable
income to the extent such deductions
were allowable under section 704(d).
See the preamble to the Final
Regulations for a discussion of the
rationale for these adjustments.
The preamble to the Final Regulations
noted that, in the 2018 Proposed
Regulations, § 1.163(j)–1(b)(1)(ii)(C)
incorporated a ‘‘lesser of’’ standard. In
other words, the lesser of (i) the amount
of gain on the sale or other disposition
of property, or (ii) the amount of
depreciation deductions with respect to
such property for the EBITDA period,
was required to be subtracted from
tentative taxable income to determine
ATI. As explained in the preamble to
the Final Regulations, commenters
raised several questions regarding this
‘‘lesser of’’ standard. The Final
Regulations removed the ‘‘lesser of’’
approach due in part to concerns that
this approach would be more difficult to
administer than the approach reflected
in the Final Regulations.
However, the Treasury Department
and the IRS recognize that, in certain
cases, the ‘‘lesser of’’ approach might
not create administrative difficulties for
taxpayers. Thus, these Proposed
Regulations permit taxpayers to choose
whether to compute the amount of their
adjustment using a ‘‘lesser of’’ standard.
While the 2018 Proposed Regulations
applied this standard solely to
dispositions of property, these Proposed
Regulations extend this standard to
dispositions of partnership interests and
member stock to eliminate the
discontinuity between the amount of the
adjustment for these different types of
dispositions. Taxpayers opting to use
this alternative computation method
must do so for all sales or other
dispositions that otherwise would be
subject to § 1.163(j)–1(b)(1)(ii)(C), (D), or
(E) when the taxpayer computes
tentative taxable income.
The Treasury Department and the IRS
request comments on the ‘‘lesser of’’
approach, including how such an
approach should apply to dispositions
of member stock and partnership
interests.
B. Dividends From Regulated
Investment Company (RIC) Shares
Some commenters on the 2018
Proposed Regulations recommended
that dividend income from a RIC be
treated as interest income for a
shareholder in a RIC, to the extent that
the income earned by the RIC is interest
income. Because a RIC is a subchapter
C corporation, section 163(j) applies at
the RIC level, and any BIE that is
disallowed at the RIC level is carried
forward to subsequent years at the RIC
level. Furthermore, because a RIC is a
subchapter C corporation, a shareholder
in a RIC generally does not take into
account a share of the RIC’s items of
income, deduction, gain, or loss. Thus,
if a RIC’s BII exceeds its BIE in a taxable
year, the RIC may not directly allocate
the excess amount to its shareholders
(unlike a partnership, which may
allocate excess BII to its partners).
Under part 1 of subchapter M and
other Code provisions, however, a RIC
that has certain items of income or gain
may pay dividends that a shareholder in
the RIC may treat in the same manner
(or a similar manner) as the shareholder
would treat the underlying items of
income or gain if the shareholder
realized the items directly. Although
this treatment differs fundamentally
from the passthrough treatment of
partners or trust beneficiaries, this
Explanation of Provisions refers to this
treatment as ‘‘conduit treatment.’’ For
example, under sections 871(k)(1) and
881(e)(1), a RIC that has qualified
interest income within the meaning of
section 871(k)(1)(E) may pay interest-
related dividends, and no tax generally
would be imposed under sections
871(a)(1)(A) or 881(a)(1) on an interest-
related dividend paid to a nonresident
alien individual or foreign corporation.
Section 871(k)(1) provides necessary
limits and procedures that apply to
interest-related dividends. The Code
provides similar conduit treatment for
capital gain dividends in section
852(b)(3), exempt-interest dividends in
section 852(b)(5), short-term capital gain
dividends in section 871(k)(2),
dividends eligible for the dividends
received deduction in section
854(b)(1)(A), and qualified dividend
income in section 854(b)(1)(B).
In response to comments, these
Proposed Regulations provide rules
under which a RIC that earns BII may
pay section 163(j) interest dividends. A
shareholder that receives a section
163(j) interest dividend may treat the
dividend as interest income for
purposes of section 163(j), subject to
holding period requirements and other
limitations. A section 163(j) interest
dividend that meets these requirements
is treated as BII if it is properly allocable
to a non-excepted trade or business of
the shareholder. A section 163(j) interest
dividend is treated as interest income
solely for purposes of section 163(j).
The rules under which a RIC may
report section 163(j) interest dividends
are based on the rules for reporting
exempt-interest dividends in section
852(b)(5) and interest-related dividends
in section 871(k)(1). The total amount of
a RIC’s section 163(j) interest dividends
for a taxable year is limited to the excess
of the RIC’s BII for the taxable year over
the sum of the RIC’s BIE for the taxable
year and the RIC’s other deductions for
the taxable year that are properly
allocable to the RIC’s BII. For some
types of income and gain to which
conduit treatment applies, the gross
amount of the RIC’s income or gain of
that type serves as the limit on the RIC’s
corresponding dividends. It would be
inconsistent with the purposes of
section 163(j) to permit a RIC to pay
section 163(j) interest dividends in an
amount based on the RIC’s gross BII,
unreduced by the RIC’s BIE. Further
reducing the limit on a RIC’s section
163(j) interest dividends by the amount
of the RIC’s other deductions that are
properly allocable to the RIC’s BII is
consistent with the provisions of the
Code that provide conduit treatment for
types of interest earned by a RIC. For
example, the limit on interest-related
dividends in section 871(k)(1)(D) is
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reduced by the deductions properly
allocable to the RIC’s qualified interest
income. Similarly, the limit on exempt-
interest dividends in section
852(b)(5)(A)(iv)(V) is reduced by the
amounts disallowed as deductions
under sections 265 and 171(a)(2).
Taking into account the appropriate
share of deductions also reduces the
likelihood that the sum of a RIC’s items
that are eligible for conduit treatment
and that are relevant to a particular
shareholder will exceed the amount of
the dividend distribution paid to the
particular shareholder.
These Proposed Regulations contain
an additional limit to prevent
inconsistent treatment of RIC dividends
by RIC shareholders. Revenue Ruling
2005–31, 2005–1 C.B. 1084, allows a
RIC to report the maximum amount of
capital gain dividends, exempt-interest
dividends, interest-related dividends,
short-term capital gain dividends,
dividends eligible for the dividends
received deduction, and qualified
dividend income for a taxable year, even
if the sum of the reported amounts
exceeds the amount of the RIC’s
dividends for the taxable year. The
ruling allows different categories of
shareholders (United States persons and
nonresident aliens) to report the
dividends they receive by giving effect
to the conduit treatment of the items
relevant to them. A single shareholder,
however, generally does not benefit
from the conduit treatment of amounts
in excess of the dividend paid to that
shareholder, because to do so would
require the shareholder to include in its
taxable income amounts exceeding the
dividend it received. Conduit treatment
of BII, however, differs from the conduit
treatment of other items, because a
section 163(j) interest dividend is
treated as interest income only for
purposes of section 163(j). Thus, absent
a limit, a RIC shareholder could obtain
an inappropriate benefit by treating a
portion of a RIC dividend as interest
income for purposes of section 163(j)
while treating the same portion of the
dividend as another non-interest type of
income, such as a dividend eligible for
the dividends received deduction under
sections 243 and 854(b). Therefore,
these Proposed Regulations limit the
amount of a section 163(j) interest
dividend that a shareholder may treat as
interest income for purposes of section
163(j) to the excess of the amount of the
RIC dividend that includes the section
163(j) interest dividend over the sum of
the portions of that dividend affected by
conduit treatment in the hands of that
shareholder, other than interest-related
dividends under section 871(k)(1)(C)
and section 163(j) interest dividends.
Under these Proposed Regulations, a
shareholder generally may not treat a
section 163(j) interest dividend as
interest income unless it meets certain
holding period and similar
requirements. The holding period
requirements do not apply to (i)
dividends paid by a RIC regulated as a
money market fund under 17 CFR
270.2a–7 or (ii) certain regular
dividends paid by a RIC that declares
section 163(j) interest dividends on a
daily basis and distributes such
dividends on a monthly or more
frequent basis. The Treasury
Department and the IRS request
comments on whether there are other
categories of section 163(j) interest
dividends for which the holding period
requirements should not apply or
should be modified. The Treasury
Department and the IRS also request
comments on whether any payments
that are substitutes for section 163(j)
interest dividends (for example, in a
securities lending or sale-repurchase
transaction with respect to RIC shares)
should be treated for purposes of section
163(j) as interest expense of taxpayers
making the payments or interest income
to taxpayers receiving the payments. Cf.
§ 1.163(j)–1(b)(22)(iii)(C) (addressing
certain payments that are substitutes for
interest).
These Proposed Regulations, to the
extent they concern the payment of
section 163(j) interest dividends by a
RIC and the treatment of such dividends
as interest by a RIC shareholder, are
proposed to apply to taxable years
beginning on or after the date that is 60
days after the date the Treasury decision
adopting these regulations as final
regulations is published in the Federal
Register. Solely in the case of section
163(j) interest dividends that would be
exempt from the holding period rules
under these Proposed Regulations, the
RIC paying such dividends and the
shareholders receiving such dividends
may rely on the provisions of these
Proposed Regulations pertaining to
section 163(j) interest dividends for
taxable years ending on or after
September 14, 2020, and beginning
before the date that is 60 days after the
date the Treasury decision adopting
these regulations as final regulations is
published in the Federal Register.
IV. Proposed § 1.163(j)–6: Application
of the Business Interest Expense
Deduction Limitations to Partnerships
and Subchapter S Corporations
A. Trading Partnerships
The preamble to the 2018 Proposed
Regulations states that the business
interest expense of certain passthrough
entities, including S corporations,
allocable to trade or business activities
that are described in section
163(d)(5)(A)(ii) (i.e., activities that are
per se non-passive under section 469 in
which the taxpayer does not materially
participate) and illustrated in Revenue
Ruling 2008–12, 2008–1 C.B. 520
(March 10, 2008) (trading activities),
will be subject to section 163(j) at the
entity level, even if the interest expense
is later subject to limitation under
section 163(d) at the individual partner
or shareholder level. Accordingly, at
least with respect to partnerships, to the
extent that interest expense from a
trading activity is limited under section
163(j) and becomes a carryover item of
partners who do not materially
participate in the trading activity, the
interest expense will be treated as
investment interest in the hands of
those partners for purposes of section
163(d) once the interest expense is no
longer limited under section 163(j). As
a result, the interest expense would be
subject to two section 163 limitations.
The Treasury Department and the IRS
received multiple comments
questioning this interpretation of
section 163(j)(5) and its interaction with
section 163(d)(5)(A)(ii). Specifically,
commenters stated that the
interpretation improperly results in the
application of section 163(j) to
partnerships engaged in a trade or
business activity of trading personal
property (including marketable
securities) for the account of owners of
interests in the activity, as described in
§ 1.469–1T(e)(6) (trading partnerships).
At issue is the extent to which BIE of
trading partnerships should be subject
to limitation under section 163(j). This
issue involves the definition of BIE
under section 163(j)(5) and, more
specifically, the second sentence of
section 163(j)(5), which generally
provides that BIE shall not include
investment interest within the meaning
of section 163(d).
The approach described in the
preamble to the 2018 Proposed
Regulations interprets section 163(j)(5)
as simply providing that interest
expense cannot be both BIE and
investment interest expense in the
hands of the same taxpayer. Under this
interpretation, section 163(j)(5) will
treat interest as investment interest
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where conflicting provisions may
otherwise subject an amount of interest
expense to limitation under both section
163(j) and section 163(d) with respect to
the same taxpayer (for example, interest
expense allocable to business assets
comprising ‘‘working capital’’ as that
term is used in section 469(e)(1)(B)). In
addition, this approach views the
partnership as an entity separate from
its partners for purposes of section
163(j) to the partnership and section
163(d) at the individual partner level.
Several commenters disagreed with this
interpretation of section 163(j)(5),
asserting that the second sentence of
section 163(j)(5) unequivocally provides
that interest expense can never be
subject to limitation under both section
163(j) and section 163(d) under any
circumstances. Based on these
comments, the Treasury Department
and the IRS considered three alternative
approaches for interpreting section
163(j)(5).
One approach would require a
partnership engaged in a trading activity
to apply section 163(j) at the partnership
level to all of the partnership’s interest
expense from the trading activity. Under
this approach, any deductible interest
expense from the partnership’s trading
activity would not be subject to any
further limitation under section 163(d)
at the individual partner level. This
interpretation would respect the
partnership as an entity separate from
its partners for purposes of section
163(j), but would treat section 163(j)(4)
and (5) as superseding section
163(d)(5)(A)(ii).
A second approach would require a
partnership engaged in a trading activity
to bifurcate its interest expense from a
trading activity between partners that
materially participate in the trading
activity and partners that are passive
investors in the activity, and subject
only the portion that is allocable to the
materially participating partners to
limitation under section 163(j). Under
this approach, to the extent any interest
expense is allocable to passive investors
in the trading activity, the interest
expense would be subject only to
section 163(d) at the partner level and
would never be subject to section 163(j)
at the partnership level.
A third approach would require a
partnership to treat all of the interest
expense from a trading activity as
investment interest under section
163(d), regardless of whether any
individual partners materially
participate in the trading activity. Under
this approach, the interest expense
properly allocable to materially
participating partners would never be
subject to limitation under section
163(j), even though interest expense
allocable to materially participating
partners would also not be subject to
limitation under section 163(d) at the
individual partner level.
After considering the comments,
Treasury Department and the IRS have
concluded that the approach described
in the preamble to the 2018 Proposed
Regulations is inconsistent with the
statutory language and intent of section
163(j)(5) because the second sentence of
section 163(j)(5) specifically states that
BIE shall not include investment
interest expense. In addition, the
Treasury Department and the IRS have
determined that the second alternative
approach, as described earlier, appears
to be the most consistent with the intent
of sections 163(d) and 163(j).
Accordingly, these Proposed
Regulations would interpret section
163(j)(5) as requiring a trading
partnership to bifurcate its interest
expense from a trading activity between
partners that materially participate in
the trading activity and partners that are
passive investors, and as subjecting only
the portion of the interest expense that
is allocable to the materially
participating partners to limitation
under section 163(j) at the partnership
level. The portion of interest expense
from a trading activity allocable to
passive investors will be subject to
limitation under section 163(d) at the
partner level, as provided in section
163(d)(5)(A)(ii).
In addition, these Proposed
Regulations require that a trading
partnership bifurcate all of its other
items of income, gain, loss and
deduction from its trading activity
between partners that materially
participate in the partnership’s trading
activity and partners that are passive
investors. The portion of the
partnership’s other items of income,
gain, loss or deduction from its trading
activity properly allocable to the passive
investors in the partnership will not be
taken into account at the partnership
level as items from a trade or business
for purposes of applying section 163(j)
at the partnership level. Instead, all
such partnership items properly
allocable to passive investors will be
treated as items from an investment
activity of the partnership, for purposes
of sections 163(j) and 163(d).
This approach, in order to be
effective, adopts the presumption that a
trading partnership generally will
possess knowledge regarding whether
its individual partners are material
participants in its trading activity. No
rules currently exist requiring a partner
to inform the partnership whether the
partner has grouped activities of the
partnership with other activities of the
partner outside of the partnership.
Therefore, the partnership might
possess little or no knowledge regarding
whether an individual partner has made
such a grouping. Without this
information, a trading partnership may
presume that an individual partner is a
passive investor in the partnership’s
trading activity based solely on the
partnership’s understanding as to the
lack of work performed by the partner
in that activity, whereas the partner may
in fact be treated as a material
participant in the partnership’s trading
activity by grouping that activity with
one or more activities of the partner in
which the partner materially
participates. In order to avoid this result
and the potential for abuse, a new rule
is proposed for the section 469 activity
grouping rules to provide that any
activity described in section
163(d)(5)(A)(ii) may not be grouped
with any other activity of the taxpayer,
including any other activity described
in section 163(d)(5)(A)(ii). The Treasury
Department and the IRS invite
comments regarding whether other
approaches may be feasible and
preferable to a special rule that prohibits
the grouping of trading activities with
other activities of a partner, such as
adoption of a rule or reporting regime
requiring all partners in the partnership
to annually certify or report to the
partnership whether they are material
participants in a grouped activity that
includes the partnership’s trading
activity.
The Treasury Department and the IRS
further invite comments regarding
whether similar rules should be adopted
with respect to S corporations that may
also be involved in trading activities,
and whether such rules would be
compatible with Subchapter S (for
example, whether the bifurcation of
items from the S corporation’s trading
activity between material participants
and passive investors would run afoul
of the second class of stock prohibition).
B. Fungibility of Publicly Traded
Partnerships
In order to be freely marketable, each
unit of a publicly traded partnership
(PTP), as defined in § 1.7704–1, must
have identical economic and tax
characteristics so that such PTP units
are fungible. For PTP units to be
fungible, the section 704(b) capital
account associated with each unit must
be economically equivalent to the
section 704(b) capital account of all
other units of the same class, and a PTP
unit buyer must receive equivalent tax
allocations regardless of the specific
unit purchased. In other words, from the
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perspective of a buyer, a PTP unit
cannot have variable tax attributes
depending on the identity of the PTP
unit seller. In general, to achieve
fungibility, a PTP (1) makes a section
754 election, pursuant to which a
purchaser can insulate itself from its
predecessor’s allocable section 704(c)
gain or loss through a section 743(b)
basis adjustment, and (2) adopts the
remedial allocation method under
section 704(c) for all of its assets.
Pursuant to § 1.704–3(d)(1), a
partnership adopts the section 704(c)
remedial allocation method to eliminate
distortions caused by the application of
the ceiling rule, as defined in § 1.704–
3(b)(1), under the section 704(c)
traditional method. A partnership
adopting the remedial allocation
method eliminates ceiling rule
distortions by creating remedial items
and allocating those items to its
partners. Under the remedial allocation
method, a partnership first determines
the amount of section 704(b) book items
under § 1.704–3(d)(2) and the partners’
section 704(b) distributive shares of
such items. The partnership then
allocates the corresponding tax items
recognized by the partnership, if any,
using the traditional method described
in § 1.704–3(b)(1). If the ceiling rule
causes the section 704(b) book
allocation of an item to a
noncontributing partner to differ from
the tax allocation of the same item to the
noncontributing partner, the partnership
creates a remedial item of income, gain,
loss, or deduction equal to the full
amount of the difference and allocates it
to the noncontributing partner. The
partnership simultaneously creates an
offsetting remedial item in an identical
amount and allocates it to the
contributing partner. In sum, by
coupling the remedial allocation
method with a section 754 election, PTP
units remain fungible from a net tax
perspective, regardless of the PTP unit
seller’s section 704(c) position.
However, even when the remedial
allocation method is coupled with a
section 754 election, the application of
section 163(j) in the partnership context
results in variable tax attributes for a
buyer depending upon the tax
characteristics of the interest held by the
seller. The Treasury Department and the
IRS have determined this is an
inappropriate result for PTPs because
PTPs, unlike other partnerships, always
require that tax attributes be
proportionate to economic attributes to
retain the fungibility of their units. The
Treasury Department and the IRS have
determined that the manner in which
section 163(j) applies in the partnership
context should not result in the non-
fungibility of PTP units. Accordingly,
these Proposed Regulations provide a
method, solely for PTPs, for applying
section 163(j) in a manner that does not
result in PTP units lacking fungibility.
Specifically, commenters identified
three ways in which the 2018 Proposed
Regulations may cause PTP units to be
non-fungible. First, the method for
allocating excess items may cause PTP
units to be non-fungible. In general,
under § 1.163(j)–6(f)(2), the allocation of
the components of ATI dictate the
allocation of a partnership’s deductible
BIE and section 163(j) excess items.
Consequently, the unequal sharing of
inside basis, including cost-recovery
deductions, amortization, gain, and loss
affects the ratio in which a partnership’s
section 163(j) excess items, as defined in
§ 1.163(j)–6(b)(6), are shared. A partner’s
share of section 163(j) excess items
affects the tax treatment and economic
consequences of the partner. For
example, a greater share of excess
taxable income enables a partner subject
to section 163(j) to deduct more interest.
The Treasury Department and the IRS
recognize that a non-pro rata sharing of
inside basis could result in a non-pro
rata allocation of excess items, which
may result in PTP units lacking
fungibility. Therefore, these Proposed
Regulations would amend § 1.163(j)–
6(f)(1)(iii) to provide that, solely for
purposes of section 163(j), a PTP
allocates section 163(j) excess items in
accordance with the partners’ shares of
corresponding section 704(b) items that
comprise ATI.
Second, the required adjustments to
partner ATI for partner basis items (e.g.,
section 743(b) income and loss) may
cause PTP units to lack fungibility. A
non-pro rata sharing of inside basis may
result in a different allocation of partner
basis items, as defined in § 1.163(j)–
6(b)(2), and section 704(c) remedial
items, as defined in § 1.163(j)–6(b)(3),
among partners. Pursuant to § 1.163(j)–
6(d)(2), partner basis items and remedial
items are not taken into account in
determining a partnership’s ATI under
§ 1.163(j)–1(b)(1). Instead, partner basis
items and section 704(c) remedial items
affect the tax treatment and economic
consequences of the partner. Similar to
the disproportionate sharing of excess
items discussed earlier, the
disproportionate sharing of partner basis
items and section 704(c) remedial items
among partners may cause PTP units to
lack fungibility.
The Treasury Department and the IRS
recognize that a non-pro rata sharing of
inside basis could result in different
partner basis items and remedial items
being allocated to different partners.
Therefore, these Proposed Regulations
would amend § 1.163(j)–6(e)(2)(ii) to
provide that, solely for the purpose of
determining remedial items under
section 163(j), a PTP either allocates
gain or loss that would otherwise be
allocated under section 704(c) to a
specific partner to all partners based on
each partner’s section 704(b) sharing
ratio, or, for purposes of allocating cost
recovery deductions under section
704(c), determines each partner’s
remedial items based on an allocation of
the partnership’s inside basis items
among its partners in proportion to their
share of corresponding section 704(b)
items, rather than applying the
traditional method as described in
§ 1.704–3(b).
Third, the treatment of section 704(c)
remedial income allocations for taxable
years beginning before 2022 may cause
PTP units to lack fungibility. For taxable
years beginning before January 1, 2022,
when tentative taxable income is not
reduced by depreciation and
amortization deductions for purposes of
determining ATI, a buyer acquiring PTP
units with section 704(c) remedial
income allocations (and an offsetting
section 743(b) adjustment) will have an
increase to its ATI that exceeds that of
a buyer of the same number of otherwise
fungible units that is not stepping into
section 704(c) remedial income (with no
corresponding section 743(b)
deduction). While the net amount of the
section 743(b) and section 704(c)
remedial items is the same to both
buyers, for taxable years beginning
before January 1, 2022, different units
would affect a buyer’s ATI differently.
The section 704(c) remedial income of
a buyer of units with section 704(c)
remedial income would be included in
its ATI, while the section 743(b)
deductions would not. Thus, a buyer of
units with section 704(c) remedial
income would increase its ATI each
year (before 2022). A buyer of units with
no section 704(c) remedial income,
however, would add back any remedial
depreciation and amortization
deductions before 2022, and its ATI
would be unaffected by the remedial
deductions for such years.
The Treasury Department and the IRS
recognize that, before 2022, a buyer of
PTP units with inherent section 704(c)
gain would include any remedial
income and would not include section
743(b) deductions in its ATI. Therefore,
these Proposed Regulations would
amend § 1.163(j)–6(d)(2)(ii) to provide
that, solely for purposes of section
163(j), a PTP treats the amount of any
section 743(b) adjustment of a purchaser
of a partnership unit that relates to a
remedial item that the purchaser
inherits from the seller as an offset to
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the related section 704(c) remedial item.
The Treasury Department and the IRS
request comments as to whether the
approaches outlined adequately resolves
the fungibility issues created by section
163(j).
C. Treatment of Business Interest
Income and Business Interest Expense
With Respect to Lending Transactions
Between a Partnership and a Partner
(Self-Charged Lending Transactions)
The 2018 Proposed Regulations
reserved on the treatment of BII and BIE
with respect to lending transactions
between a partnership and a partner
(self-charged lending transactions). The
preamble to the 2018 Proposed
Regulations requested comments
regarding self-charged lending
transactions. One commenter
recommended the final regulations
include rules under § 1.163(j)–6(n) akin
to those contained in § 1.469–7 to
identify self-charged interest income
and expense and further allow such self-
charged interest income and expense to
be excluded from the definition of BIE
and BII under section 163(j)(5) and (6),
respectively. The same commenter
recommended that the final regulations
retain the rule in § 1.163(j)–3(b)(4), as
set forth in the 2018 Proposed
Regulations, which applies the section
163(j) limitation prior to the application
of the passive activity loss rules of
section 469. Other commenters
recommended the Final Regulations
exclude BIE and BII from the section
163(j) calculation where a partner or S-
corporation shareholder lends to, or
borrows from, a passthrough entity.
These commenters recommended that
the amount excluded be based on the
amount of income or expense
recognized by partners or shareholders
that are lenders or borrowers, as well as
partners or shareholders that are related
to a lender or borrower partner within
the meaning of section 267(b) because it
would be appropriate to exclude the BII
and BIE realized by the related parties
for purposes of the section 163(j)
calculation.
In response to these comments, the
Treasury Department and the IRS
propose adding a rule in proposed
§ 1.163(j)–6(n) to provide that, in the
case of a lending transaction between a
partner (lending partner) and
partnership (borrowing partnership) in
which the lending partner owns a direct
interest (self-charged lending
transaction), any BIE of the borrowing
partnership attributable to the self-
charged lending transaction is BIE of the
borrowing partnership for purposes of
§ 1.163(j)–6. If in a given taxable year
the lending partner is allocated EBIE
from the borrowing partnership and has
interest income attributable to the self-
charged lending transaction (interest
income), the lending partner shall treat
such interest income as an allocation of
excess business interest income (EBII)
from the borrowing partnership in such
taxable year, but only to the extent of
the lending partner’s allocation of EBIE
from the borrowing partnership in such
taxable year. To prevent the double
counting of BII, the lending partner
includes interest income that was re-
characterized as EBII pursuant to
proposed § 1.163(j)–6(n) only once
when calculating the lending partner’s
own section 163(j) limitation. In cases
where the lending partner is not a C
corporation, to the extent that any
interest income exceeds the lending
partner’s allocation of EBIE from the
borrowing partnership for the taxable
year, and such interest income
otherwise would be properly treated as
investment income of the lending
partner for purposes of section 163(d)
for that year, such excess amount of
interest income will continue to be
treated as investment income of the
lending partner for that year for
purposes of section 163(d).
The Treasury Department and the IRS
generally agree that lending partners
should not be adversely affected by the
fact that, without special rules, the
interest income received at the partner
level from such lending transactions
generally will be treated as investment
income if the partner is not engaged in
the trade or business of lending money,
while the BIE of the partnership will be
subject to section 163(j) and potentially
limited at the partner level as EBIE. This
situation would create a mismatch
between the character of the interest
income and of the interest expense at
the partner level from the same lending
transaction. These proposed rules
would apply only to items of interest
income attributable to the lending
transaction and EBIE from the same
partnership that arise in the same
taxable year of the lending partner. By
applying these proposed rules only to
correct a mismatch in character that
may occur at the partner level during a
single taxable year, these proposed rules
otherwise ensure that a partnership
engaged in a self-charged lending
transaction will be subject to the rules
of section 163(j) to the same extent
regardless of the sources of its loans.
These proposed rules will not apply
in the case of an S corporation because
BIE of an S corporation is carried over
by the S corporation as a corporate-level
attribute rather than immediately passed
through to its shareholders. In the year
such disallowed BIE is deductible at the
corporate level, it is not separately
stated, and it is not subject to further
limitation under section 163(j) at either
the S corporation or shareholder level.
Therefore, a limited self-charged rule to
ensure proper matching of the character
of interest income and BIE at the
shareholder level is not necessary. This
approach is consistent with the
treatment of S corporations as separate
entities from their owners, both
generally and specifically with respect
to section 163(j).
However, the Treasury Department
and the IRS recognize that issues
analogous to the issues faced by
partnerships in self-charged lending
transactions exist with respect to
lending transactions between S
corporations and their shareholders.
The Treasury Department and the IRS
request comments on whether a similar
rule is appropriate for S corporations in
light of section 163(j)(4)(B) not applying
and, if so, how such rule should be
structured.
D. Partnership Basis Adjustments Upon
Partner Dispositions
In general, a partnership’s disallowed
BIE is allocated to its partners as EBIE
rather than carried forward at the
partnership level in order to prevent the
trafficking of deductions for BIE
carryforwards in the partnership
context. To achieve this, section
163(j)(4)(B)(iii)(I) provides that the
adjusted basis of a partner in a
partnership interest is reduced (but not
below zero) by the amount of EBIE
allocated to the partner. If a partner
disposes of a partnership interest,
section 163(j)(4)(B)(iii)(II) provides that
the adjusted basis of the partner in the
partnership interest is increased
immediately before the disposition by
the amount of any EBIE that was not
treated as BIE paid or accrued by the
partner prior to the disposition. Further,
under section 163(j)(4)(B)(iii)(II), no
deduction shall be allowed to the
transferor or transferee for any EBIE
resulting in a basis increase.
The Treasury Department and the IRS
have determined that the basis increase
required by section 163(j)(4)(B)(iii)(II) is
not fully descriptive of what is
occurring when a partner with EBIE
disposes of its partnership interest. If
EBIE is not treated as BIE paid or
accrued by the partner pursuant to
§ 1.163(j)–6(g) prior to the partner
disposing of its partnership interest
(nondeductible EBIE), section
163(j)(4)(B)(iii)(II) treats such
nondeductible EBIE as though it were a
nondeductible expense of the
partnership.
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This nondeductible expense is not a
nondeductible, non-capitalizable
expense under section 705(a)(2)(B). If it
were, the partner’s basis in its
partnership interest at the time of the
disposition would already reflect such
an expense. Instead, section
163(j)(4)(B)(iii)(II) requires the partner to
increase its basis immediately before the
disposition—in effect, treating the
partner as though the partnership made
a payment that decreased the value of
the partnership interest but did not
affect the partner’s basis in its
partnership interest. Thus, upon a
disposition, section 163(j)(4) treats
nondeductible EBIE as though it were a
nondeductible, capitalizable expense of
the partnership.
While the statute is clear that a
partner increases the basis in its
partnership interest immediately prior
to a disposition by any nondeductible
EBIE, it does not specifically state that
there must also be a corresponding
increase to the basis of partnership
assets to account for the nondeductible,
capitalized expense (i.e., the
nondeductible EBIE). The absence of a
corresponding increase to the
partnership’s basis immediately before
the partner’s disposition would create
distortions that are inconsistent with the
intent of both section 163(j) and
subchapter K of the Code.
For example, the basis increase
attributable to nondeductible EBIE
immediately before a liquidating
distribution results in less gain
recognized under section 731(a)(1) (or
more loss recognized under section
731(a)(2)) for the partner disposing of its
partnership interest. Consequently,
following a liquidating distribution to a
partner with EBIE, section
163(j)(4)(B)(iii)(II) causes a reduced
section 734(b) adjustment if the
partnership has a section 754 election in
effect (versus the partner basis increase
not occurring), resulting in basis
disparity between the partnership’s
basis in its assets and the aggregate
outside basis of the remaining partners.
To illustrate, consider the following
example. In Year 1, A, B, and C formed
partnership PRS by each contributing
$1,000 cash. PRS borrowed $900,
causing each partner’s basis in PRS to
increase by $300. Also in Year 1, PRS
purchased Capital Asset X for $200. In
Year 2, PRS pays $300 of BIE, all of
which is disallowed and treated as
EBIE. PRS allocated the $300 of EBIE to
its partners, $100 each. Pursuant to
§ 1.163(j)–6(h)(2), each partner reduced
its outside basis by its $100 allocation
of EBIE to $1,200. In Year 3, when the
fair market value of Capital Asset X is
$3,200 and no partner’s basis in PRS has
changed, PRS distributed $1,900 to C in
complete liquidation of C’s partnership
interest. PRS has a section 754 election
in effect in Year 3.
Pursuant to § 1.163(j)–6(h)(3), C
increases the adjusted basis of its
partnership interest by $100
immediately before the disposition.
Thus, C’s section 731(a)(1) gain
recognized on the disposition of its
partnership interest is $900 (($1,900
cash + $300 relief of liabilities)¥($1,200
outside basis + $100 EBIE add-back)).
Because the election under section 754
is in effect, PRS has a section 734(b)
increase to the basis of its assets of $900
(the amount of section 731(a)(1) gain
recognized by C). Under section 755, the
entire adjustment is allocated to Capital
Asset X. As a result, PRS’s basis for
Capital Asset X is $1,100 ($200 + $900
section 734(b) adjustment). Following
the liquidation of C, PRS’s basis in its
assets ($1,500 of cash + $1,100 of
Capital Asset X) does not equal the
aggregate outside basis of partners A
and B ($2,700).
The Treasury Department and the IRS
have determined that basis disparity
resulting from the absence of a
corresponding inside basis increase, as
described earlier, is an inappropriate
result. Accordingly, these Proposed
Regulations would provide for a
corresponding inside basis increase that
would serve as the partnership analog of
section 163(j)(4)(B)(iii)(II). Specifically,
proposed § 1.163(j)–6(h)(5) would
provide that if a partner (transferor)
disposes of its partnership interest, the
partnership shall increase the adjusted
basis of partnership property by an
amount equal to the amount of the
increase required under § 1.163(j)–
6(h)(3), if any, to the adjusted basis of
the partnership interest being disposed
of by the transferor. Such increase in the
adjusted basis of partnership property
(§ 1.163(j)–6(h)(5) basis adjustment)
shall be allocated among partnership
properties in the same manner as a
positive section 734(b) adjustment.
Because a § 1.163(j)–6(h)(5) basis
adjustment is taken into account when
determining the gain or loss upon a sale
of the asset, a § 1.163(j)–6(h)(5) basis
adjustment prevents the shifting of
built-in gain to the remaining partners.
These Proposed Regulations would
adopt an approach that treats the
increase in the adjusted basis of any
partnership property resulting from a
§ 1.163(j)–6(h)(5) basis adjustment as
not depreciable or amortizable under
any section of the Code, regardless of
whether the partnership property
allocated such § 1.163(j)–6(h)(5) basis
adjustment is otherwise generally
depreciable or amortizable. This
approach perceives EBIE as a deduction
that was disallowed to the partnership
(consistent with section
163(j)(4)(B)(iii)(II)), and thus should not
result in a depreciable section 734(b)
basis adjustment.
The Treasury Department and the IRS
request comments on this approach. An
alternative approach considered by the
Treasury Department and the IRS would
treat a § 1.163(j)–6(h)(5) basis
adjustment as depreciable or
amortizable if it is allocated to
depreciable or amortizable property.
However, section 163(j)(4)(B)(iii)(II)
provides that no deduction shall be
allowed to the transferor or transferee
for any EBIE resulting in a basis increase
to the partner that disposed of its
interest. If a § 1.163(j)–6(h)(5) basis
adjustment were depreciable or
amortizable, a partnership—which can
arguably be viewed as a transferee in a
transaction in which a partner receives
a distribution in complete liquidation of
its partnership interest—could
effectively deduct an expense that
section 163(j)(4)(B)(iii)(II) states is
permanently disallowed. The Treasury
Department and the IRS request
comments on whether treating a
§ 1.163(j)–6(h)(5) basis adjustment as
potentially depreciable or amortizable is
consistent with section
163(j)(4)(B)(iii)(II).
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
1. Entity Approach
The preamble to the 2018 Proposed
Regulations reserved and requested
comments on the application of section
163(j)(4) to tiered partnership structures.
Specifically, the preamble to the 2018
Proposed Regulations requested
comments regarding whether, in a tiered
partnership structure, EBIE should be
allocated through an upper-tier
partnership to the partners of upper-tier
partnership. Additionally, comments
were requested regarding how and when
the basis of an upper-tier partnership
partner should be adjusted when a
lower-tier partnership has BIE that is
limited under section 163(j).
In response, commenters
recommended approaches that, in
general, either (1) allocated EBIE
through upper-tier partnership to the
partners of upper-tier partnership
(Aggregate Approach), or (2) did not
allocate EBIE through upper-tier
partnership to the partners of upper-tier
partnership (Entity Approach).
Commenters stated that both approaches
reasonably implement Congressional
intent of applying section 163(j) at the
partnership level; however, the Entity
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Approach reflects a stronger allegiance
to entity treatment of partnerships for
purposes of section 163(j). Commenters
noted that the ultimate determination of
which approach is more appropriate
should rest, in large part, on whether
partnerships or partners are more able to
comply with the provision. The Entity
Approach places more of that burden on
partnerships, and the Aggregate
Approach places more of the burden on
partners. Commenters recommended
that partnerships are better able to
comply with an Entity Approach than
partners are able to comply with an
Aggregate Approach. Further, because
the Entity Approach centers a
significant portion of the compliance
effort with partnerships, the Entity
Approach may increase compliance and
simplify Service review.
The Treasury Department and the IRS
have concluded that an Entity Approach
is the most consistent with the approach
taken to partnerships under section
163(j)(4). Further, the Treasury
Department and the IRS agree with
commenters that partnerships are better
able to comply with section 163(j) tiered
partnership rules than partners.
Accordingly, proposed § 1.163(j)–6(j)(3)
would provide that if lower-tier
partnership allocates excess business
interest expense to upper-tier
partnership, then upper-tier partnership
reduces its basis in lower-tier
partnership pursuant to § 1.163(j)–
6(h)(2). Upper-tier partnership partners
do not, however, reduce the bases of
their upper-tier partnership interests
pursuant to § 1.163(j)–6(h)(2) until
upper-tier partnership treats such excess
business interest expense as business
interest expense paid or accrued
pursuant to § 1.163(j)–6(g).
Although proposed § 1.163(j)–6(j)(3)
would provide that EBIE allocated from
a lower-tier partnership to an upper-tier
partnership is not subject to further
allocation by the upper-tier partnership,
such EBIE necessarily reflects a
reduction in the value of lower-tier
partnership by the amount of the
economic outlay that resulted in such
EBIE. Accordingly, proposed § 1.163(j)–
6(j)(2) would provide that if lower-tier
partnership pays or accrues business
interest expense and allocates such
business interest expense to upper-tier
partnership, then both upper-tier
partnership and any direct or indirect
partners of upper-tier partnership shall,
solely for purposes of section 704(b) and
the regulations thereunder, treat such
business interest expense as a section
705(a)(2)(B) expenditure. Any section
704(b) capital account reduction
resulting from such treatment occurs
regardless of whether such business
interest expense is characterized under
this section as excess business interest
expense or deductible business interest
expense by lower-tier partnership. If
upper-tier partnership subsequently
treats any excess business interest
expense allocated from lower-tier
partnership as business interest expense
paid or accrued pursuant to § 1.163(j)–
6(g), the section 704(b) capital accounts
of any direct or indirect partners of
upper-tier partnership are not further
reduced.
2. Basis and Carryforward Component of
EBIE
Some commenters stated that an
Entity Approach—that is, the approach
these Proposed Regulations would
adopt—would result in basis disparity
between upper-tier partnership’s basis
in its assets and the aggregate basis of
the upper-tier partners’ interests in
upper-tier partnership. The Treasury
Department and the IRS do not agree.
EBIE is neither an item of deduction nor
a section 705(a)(2)(B) expense. If an
allocation of EBIE from lower-tier
partnership results in a reduction of the
upper-tier partnership’s basis in its
lower-tier partnership interest, there is
not a net reduction in the tax attributes
of the upper-tier partnership. Rather, in
such an event, upper-tier partnership
merely exchanges one tax attribute (tax
basis in its lower-tier partnership
interest) for a different tax attribute
(EBIE, which, in a subsequent year,
could result in either a deduction or a
basis adjustment). Thus, basis is
preserved in this exchange.
Accordingly, proposed § 1.163(j)–
6(j)(4) would provide that if lower-tier
partnership allocates excess business
interest expense to upper-tier
partnership and such excess business
interest expense is not suspended under
section 704(d), then upper-tier
partnership shall treat such excess
business interest expense (UTP EBIE) as
a nondepreciable capital asset, with a
fair market value of zero and basis equal
to the amount by which upper-tier
partnership reduced its basis in lower-
tier partnership pursuant to § 1.163(j)–
6(h)(2) due to the allocation of such
excess business interest expense. The
fair market value of UTP EBIE,
described in the preceding sentence, is
not adjusted by any revaluations
occurring under § 1.704–1(b)(2)(iv)(f).
In addition to generally treating UTP
EBIE as having a basis component in
excess of fair market value and, thus,
built-in loss property, proposed
§ 1.163(j)–6(j)(4) would also provide that
upper-tier partnership shall also treat
UTP EBIE as having a carryforward
component associated with it. The
carryforward component of UTP EBIE
shall equal the amount of excess
business interest expense allocated from
lower-tier partnership to upper-tier
partnership under § 1.163(j)–6(f)(2) that
is treated as such under § 1.163(j)–
6(h)(2) by upper-tier partnership.
The carryforward component of UTP
EBIE and the basis component of such
UTP EBIE will always be equal
immediately following the allocation of
such EBIE from lower-tier partnership to
upper-tier partnership if, at the time of
such allocation, upper-tier partnership
was required to reduce its section 704(b)
capital account pursuant to proposed
§ 1.163(j)–6(j)(2) due to such allocation.
However, subsequent to such initial
allocation of EBIE from lower-tier
partnership to upper-tier partnership,
disparities between the carryforward
component of UTP EBIE and the basis
component of such UTP EBIE may arise
as a result of proposed § 1.163(j)–6(j)(7).
Similar to the treatment of partner
basis items (which do not affect the ATI
of a partnership), proposed § 1.163(j)–
6(j)(7)(i) would provide that negative
basis adjustments under sections 734(b)
and 743(b) allocated to UTP EBIE do not
affect the carryforward component of
such UTP EBIE; rather, negative basis
adjustments under sections 734(b) and
743(b) affect only the basis component
of such UTP EBIE. Although section
734(b) adjustments do affect a
partnership’s computation of ATI, the
Treasury Department and the IRS have
determined that negative section 734(b)
adjustments, if allocated to UTP EBIE,
should not reduce the carryforward
component of such UTP EBIE. The
purpose of proposed § 1.163(j)–6(j)(7)—
in addition to preventing the
duplication of loss—is to make partners
indifferent for section 163(j) purposes as
to whether a partner exiting upper-tier
partnership sells its interest or receives
a liquidating distribution from upper-
tier partnership. Excluding negative
section 734(b) adjustments from
proposed § 1.163(j)–6(j)(7) would
frustrate this purpose.
3. UTP EBIE Conversion Events
Proposed § 1.163(j)–6(j)(4) would
further provide that if an allocation of
excess business interest expense from
lower-tier partnership is treated as UTP
EBIE of upper-tier partnership, upper-
tier partnership shall treat such
allocation of excess business interest
expense from lower-tier partnership as
UTP EBIE until the occurrence of an
UTP EBIE conversion event described in
proposed § 1.163(j)–6(j)(5). In the non-
tiered context, EBIE generally has two
types of conversion events. The first
EBIE conversion event is when EBIE is
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treated as BIE paid or accrued pursuant
to § 1.163(j)–6(g). The second EBIE
conversion event is the basis addback
that occurs pursuant to proposed
§ 1.163(j)–6(h)(3) when a partner
disposes of its interest in a partnership.
Proposed § 1.163(j)–6(j)(5)(i) and (ii),
respectively, would provide guidance
regarding these two types of conversion
events in the tiered partnership context.
a. First Type of Conversion Event—UTP
EBIE Treated as Paid or Accrued
Regarding the first type of conversion
event, proposed § 1.163(j)–6(j)(5)(i)
would provide that to the extent upper-
tier partnership is allocated excess
taxable income (or excess business
interest income) from lower-tier
partnership, or § 1.163(j)–6 (m)(3)
applies, upper-tier partnership shall
apply proposed § 1.163(j)–6(j)(5)(i)(A)
through (C).
First, proposed § 1.163(j)–6(j)(5)(i)(A)
requires upper-tier partnership to apply
the rules in § 1.163(j)–6(g) to its UTP
EBIE, using any reasonable method
(including, for example, FIFO and LIFO)
to determine which UTP EBIE is treated
as business interest expense paid or
accrued pursuant § 1.163(j)–6(g). If
§ 1.163(j)–6(m)(3) applies, upper-tier
partnership shall treat all of its UTP
EBIE from lower-tier partnership as paid
or accrued.
Proposed § 1.163(j)–6(j)(5)(i)(A) would
provide that upper-tier partnership must
determine which of its UTP EBIE is
treated as paid or accrued, as opposed
to just providing that upper-tier
partnership reduces its UTP EBIE,
because UTP EBIE is not necessarily a
unified tax attribute of upper-tier
partnership. UTP EBIE of upper-tier
partnership could have been allocated
in different years, have different bases,
and have different specified partners
(defined in the next paragraph). For
example, assume $30 of UTP EBIE was
allocated a negative $10 section 734(b)
adjustment, resulting in the aggregate of
upper-tier partnership’s UTP EBIE
having a carryforward component of $30
and basis component of $20. Thus, such
UTP EBIE could, at most, result in $20
of deduction (the basis of such UTP
EBIE). However, upper-tier partnership
does not necessarily need $100 of ETI
(or $30 of EBII) to deduct such $20.
Rather, if upper-tier partnership was
allocated $20 of EBII, upper-tier
partnership could deduct $20 of
business interest expense if, using a
reasonable method, it determined the
$20 of UTP EBIE with full basis was the
UTP EBIE treated as business interest
expense paid or accrued pursuant to
§ 1.163(j)–6(j)(5)(i)(A). Following such
treatment, upper-tier partnership would
still have $10 of UTP EBIE with $0 basis
remaining (that is, $10 of carryforward
component and $0 of basis component).
Second, with respect to any UTP EBIE
treated as business interest expense paid
or accrued in proposed § 1.163(j)–
6(j)(5)(i)(A), proposed § 1.163(j)–
6(j)(5)(i)(B) would require upper-tier
partnership to allocate any business
interest expense that was formerly such
UTP EBIE to its specified partner. For
purposes of proposed § 1.163(j)–6(j), the
term specified partner refers to the
partner of upper-tier partnership that,
due to the initial allocation of excess
business interest expense from lower-
tier partnership to upper-tier
partnership, was required to reduce its
section 704(b) capital account pursuant
to proposed § 1.163(j)–6(j)(2). Similar
principles apply if the specified partner
of such business interest expense is
itself a partnership.
Proposed § 1.163(j)–6(j)(6) would
provide rules if a specified partner
disposes of its interest. Specifically,
proposed § 1.163(j)–6(j)(6)(i) would
provide that if a specified partner
(transferor) disposes of an upper-tier
partnership interest (or an interest in a
partnership that itself is a specified
partner), the portion of any UTP EBIE to
which the transferor’s status as specified
partner relates is not reduced pursuant
to proposed § 1.163(j)–6(j)(5)(ii). Stated
otherwise, if a partner of an upper-tier
partnership disposes of its interest in
the upper-tier partnership, an interest in
the lower-tier partnership held by
upper-tier partnership is not deemed to
have been similarly disposed of for
purposes of proposed § 1.163(j)–
6(j)(5)(ii). See Rev. Rul. 87–115. Rather,
such UTP EBIE attributable to the
interest disposed of is retained by
upper-tier partnership and the
transferee is treated as the specified
partner for purposes of proposed
§ 1.163(j)–6(j) with respect to such UTP
EBIE. Thus, upper-tier partnership must
allocate any business interest expense
that was formerly such UTP EBIE to the
transferee.
Additionally, proposed § 1.163(j)–
6(j)(6)(ii) would provide special rules
regarding the specified partner of UTP
EBIE following certain nonrecognition
transactions. Proposed § 1.163(j)–
6(j)(6)(ii)(A) would provide that if a
specified partner receives a distribution
of property in complete liquidation of
an upper-tier partnership interest, the
portion of UTP EBIE of upper-tier
partnership attributable to the
liquidated interest shall not have a
specified partner. If a specified partner
(transferee) receives a distribution of an
interest in upper-tier partnership in
complete liquidation of a partnership
interest, the transferee is the specified
partner with respect to UTP EBIE of
upper-tier partnership only to the same
extent it was prior to the distribution.
Similar principles apply where an
interest in a partnership that is a
specified partner is distributed in
complete liquidation of a transferee’s
partnership interest.
Proposed § 1.163(j)–6(j)(6)(ii)(B)
would further provide that if a specified
partner (transferor) contributes an
upper-tier partnership interest to a
partnership (transferee), the transferee is
treated as the specified partner for
purposes of proposed § 1.163(j)–6(j)
with respect to the portion of the UTP
EBIE attributable to the contributed
interest. Following the transaction, the
transferor continues to be the specified
partner with respect to the UTP EBIE
attributable to the contributed interest.
Similar principles apply where an
interest in a partnership that is a
specified partner is contributed to a
partnership.
Finally, after determining the
specified partner of the UTP EBIE
treated as business interest expense paid
or accrued in proposed § 1.163(j)–
6(j)(5)(i)(A) and allocating such business
interest expense to its specified partner
pursuant to proposed § 1.163(j)–
6(j)(5)(i)(B), proposed § 1.163(j)–
6(j)(5)(i)(C) would require upper-tier
partnership to, in the manner provided
in proposed § 1.163(j)–6(j)(7)(ii) (or (iii),
as the case may be), take into account
any negative basis adjustments under
section 734(b) previously made to the
UTP EBIE treated as business interest
expense paid or accrued in (A) earlier.
Additionally, persons treated as
specified partners with respect to the
UTP EBIE treated as business interest
expense paid or accrued in (A) earlier
shall take any negative basis
adjustments under section 743(b) into
account in the manner provided in
proposed § 1.163(j)–6(j)(7)(ii) (or (iii), as
the case may be).
Proposed § 1.163(j)–6(j)(7)(ii) would
provide that if UTP EBIE that was
allocated a negative section 734(b)
adjustment is subsequently treated as
deductible business interest expense,
then such deductible business interest
expense does not result in a deduction
to the upper-tier partnership or the
specified partner of such deductible
business interest expense. If UTP EBIE
that was allocated a negative section
743(b) adjustment is subsequently
treated as deductible business interest
expense, the specified partner of such
deductible business interest expense
recovers any negative section 743(b)
adjustment attributable to such
deductible business interest expense
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(effectively eliminating any deduction
for such deductible business interest
expense).
Proposed § 1.163(j)–6(j)(7)(iii) would
provide that if UTP EBIE that was
allocated a negative section 734(b) or
743(b) adjustment is subsequently
treated as excess business interest
expense, the specified partner’s basis
decrease in its upper-tier partnership
interest required under proposed
§ 1.163(j)–6(h)(2) is reduced by the
amount of the negative section 734(b) or
743(b) adjustment previously made to
such excess business interest expense. If
such excess business interest expense is
subsequently treated as business interest
expense paid or accrued by the
specified partner, no deduction shall be
allowed for any of such business
interest expense. If the specified partner
of such excess business interest expense
is a partnership, such excess business
interest expense is considered UTP EBIE
that was previously allocated a negative
section 734(b) adjustment for purposes
of proposed § 1.163(j)–6(j).
b. Second Type of Conversion Event—
UTP EBIE Reduction
Regarding the second type of
conversion event, proposed § 1.163(j)–
6(j)(5)(ii) would provide that if upper-
tier partnership disposes of a lower-tier
partnership interest (transferred
interest), upper-tier partnership shall
apply proposed § 1.163(j)–6(j)(5)(ii)(A)
through (C).
First, proposed § 1.163(j)–6(j)(5)(ii)(A)
would require upper-tier partnership to
apply the rules in § 1.163(j)–6(h)(3)
(except as provided in (B) and (C) later),
using any reasonable method
(including, for example, FIFO and LIFO)
to determine which UTP EBIE is
reduced pursuant to § 1.163(j)–6(h)(3).
Stated otherwise, proposed § 1.163(j)–
6(j)(5)(ii)(A) would require upper-tier
partnership to apply all of the rules in
§ 1.163(j)–6(h)(3), except for the rule
that determines the amount of the basis
increase immediately before the
disposition to the disposed of interest
(the first sentence of § 1.163(j)–6(h)(3)).
In lieu of applying the first sentence of
§ 1.163(j)–6(h)(3), upper-tier partnership
would apply proposed § 1.163(j)–
6(j)(5)(ii)(B) and (C) to determine the
amount of such basis increase.
Second, proposed § 1.163(j)–
6(j)(5)(ii)(B) would require upper-tier
partnership to increase the adjusted
basis of the transferred interest
immediately before the disposition by
the total amount of the UTP EBIE that
was reduced in (A) earlier (the amount
of UTP EBIE proportionate to the
transferred interest). For example, if
upper-tier partnership disposed of half
of its lower-tier partnership interest
while it held $40 of UTP EBIE allocated
from lower tier partnership, upper-tier
partnership would increase the adjusted
basis of the disposed of lower-tier
partnership interest by $20. However,
immediately before the disposition,
such $20 increase may be reduced
pursuant to proposed § 1.163(j)–
6(j)(5)(ii)(C).
Third, proposed § 1.163(j)–
6(j)(5)(ii)(C) would require upper-tier
partnership to, in the manner provided
in proposed § 1.163(j)–6(j)(7)(iv), take
into account any negative basis
adjustments under sections 734(b) and
743(b) previously made to the UTP EBIE
that was reduced in (A) earlier.
Proposed § 1.163(j)–6(j)(7)(iv) would
provide that if UTP EBIE that was
allocated a negative section 734(b) or
743(b) adjustment is reduced pursuant
to proposed § 1.163(j)–6(j)(5)(ii)(A), the
amount of upper-tier partnership’s basis
increase under proposed § 1.163(j)–
6(j)(5)(ii)(B) to the disposed of lower-tier
partnership interest is reduced by the
amount of the negative section 734(b) or
743(b) adjustment previously made to
such UTP EBIE.
Continuing with the previous
example, assume that $5 of the $20 of
UTP EBIE reduced pursuant to proposed
§ 1.163(j)–6(j)(5)(ii)(A) was previously
allocated a $5 negative section 743(b)
adjustment. Pursuant to proposed
§ 1.163(j)–6(j)(5)(ii)(C), upper-tier
partnership would reduce the $20
increase it determined under proposed
§ 1.163(j)–6(j)(5)(ii)(B) by $5. Thus, the
adjusted basis of the lower-tier
partnership interest being disposed of
would be increased by $15 immediately
before the disposition. Consequently,
lower-tier partnership would have a
corresponding § 1.163(j)–6(h)(5) basis
adjustment to its property of $15.
4. Anti-Loss Trafficking Rules
Proposed § 1.163(j)–6(j) generally
relies on negative sections 734(b) and
743(b) adjustments to prevent a partner
from deducting business interest
expense that was formerly UTP EBIE if
such partner did not bear the economic
cost of such business interest expense
payment. To the extent a negative
section 734(b) or 743(b) adjustment fails
to prohibit such a deduction (or basis
increase under proposed § 1.163(j)–
6(j)(5)(ii)), the anti-loss trafficking rules
in proposed § 1.163(j)–6(j)(8) would
prohibit such a deduction (or basis
addback under proposed § 1.163(j)–
6(j)(5)(ii)).
The anti-loss trafficking rule under
proposed § 1.163(j)–6(j)(8)(i) would
prohibit the trafficking of business
interest expense by providing that no
deduction shall be allowed to any
transferee specified partner for any
business interest expense derived from
a transferor’s share of UTP EBIE. For
purposes of proposed § 1.163(j)–6(j), the
term transferee specified partner refers
to any specified partner that did not
reduce its section 704(b) capital account
upon the initial allocation of excess
business interest expense from lower-
tier partnership to upper-tier
partnership pursuant to proposed
§ 1.163(j)–6(j)(2). However, the
transferee described in proposed
§ 1.163(j)–6(j)(ii)(B) is not a transferee
specified partner for purposes of
proposed § 1.163(j)–6(j).
Proposed § 1.163(j)–6(j)(8)(i) would
also provide the mechanism for
disallowing such BIE. Proposed
§ 1.163(j)–6(j)(8)(i) would provide that
if, pursuant to proposed § 1.163(j)–
6(j)(5)(i)(B), a transferee specified
partner is allocated business interest
expense derived from a transferor’s
share of UTP EBIE (business interest
expense to which the partner’s status as
transferee specified partner relates), the
transferee specified partner is deemed to
recover a negative section 743(b)
adjustment with respect to, and in the
amount of, such business interest
expense and takes such negative section
743(b) adjustment into account in the
manner provided in proposed
§ 1.163(j)–6(j)(7)(ii) (or (iii), as the case
may be), regardless of whether a section
754 election was in effect or a
substantial built-in loss existed at the
time of the transfer by which the
transferee specified partner acquired the
transferred interest. However, to the
extent a negative section 734(b) or
743(b) adjustment was previously made
to such business interest expense, the
transferee specified partner does not
recover an additional negative section
743(b) adjustment pursuant to this
paragraph.
Additionally, the anti-loss trafficking
rule under proposed § 1.163(j)–6(j)(8)(ii)
would prohibit the trafficking of BIE
that was formerly the UTP EBIE of a
specified partner that received a
distribution in complete liquidation of
its upper-tier partnership interest.
Specifically, proposed § 1.163(j)–
6(j)(8)(ii) would provide that if UTP
EBIE does not have a specified partner
(as the result of a transaction described
in proposed § 1.163(j)–6(j)(6)(ii)(A)),
upper-tier partnership shall not allocate
any business interest expense that was
formerly such UTP EBIE to its partners.
Rather, for purposes of applying
§ 1.163(j)–6(f)(2), upper-tier partnership
shall treat such business interest
expense as the allocable business
interest expense (as defined in
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§ 1.163(j)–6(f)(2)(ii)) of a §1.163(j)–
6(j)(8)(ii) account.
Any deductible business interest
expense and excess business interest
expense allocated to a § 1.163(j)–
6(j)(8)(ii) account at the conclusion of
the eleven-step computation set forth in
§ 1.163(j)–6(f)(2) is not tracked in future
years. Treating such business interest
expense as the allocable business
interest expense of a separate account
for purposes of applying § 1.163(j)–
6(f)(2)(ii) ensures that partners of upper-
tier partnership do not support a
deduction for such business interest
expense (for which no deduction will be
allowed) using their shares of allocable
ATI and allocable business interest
income before supporting a deduction
for their own shares of allocable
business interest expense (for which a
deduction may be allowed).
Additionally, if UTP EBIE that does
not have a specified partner (as the
result of a transaction described in
proposed § 1.163(j)–6(j)(6)(ii)(A)) is
treated as paid or accrued pursuant to
§ 1.163(j)–6(g), upper-tier partnership
shall make a § 1.163(j)–6(h)(5) basis
adjustment to its property in the amount
of the adjusted basis (if any) of such
UTP EBIE at the time such UTP EBIE is
treated as business interest expense paid
or accrued pursuant to § 1.163(j)–6(g).
The purpose of this § 1.163(j)–6(h)(5)
basis adjustment is to preserve basis in
the system.
Thus, any time upper-tier partnership
treats UTP EBIE as business interest
expense paid or accrued pursuant to
proposed § 1.163(j)–6(j)(5)(i)(A) it must
apply proposed § 1.163(j)–6(j)(8)(i) and
(ii). In application, upper-tier
partnership would generally undertake
the following analysis when applying
proposed § 1.163(j)–6(j)(8)(i) and (ii).
With respect to any UTP EBIE treated as
business interest expense paid or
accrued pursuant to proposed
§ 1.163(j)–6(j)(5)(i)(A) (UTP BIE), upper-
tier partnership must first determine
whether such UTP BIE has a specified
partner. If it does not have a specified
partner, upper-tier partnership must
apply proposed § 1.163(j)–6(j)(8)(ii),
which, in general, requires upper-tier
partnership to capitalize the basis (if
any) of such UTP BIE into the basis of
upper-tier partnership property via a
§ 1.163(j)–6(h)(5) basis adjustment.
If UTP BIE does have a specified
partner, upper-tier partnership must
next determine whether the specified
partner of such UTP BIE reduced its
section 704(b) capital account upon the
initial allocation of such excess business
interest expense from lower-tier
partnership to upper-tier partnership
pursuant to proposed § 1.163(j)–6(j)(2).
If the specified partner did reduce its
section 704(b) capital account upon
such initial allocation, then any
deduction for such UTP BIE is not
disallowed under proposed § 1.163(j)–
6(j)(8)(i). However, if the specified
partner did not reduce its section 704(b)
capital account upon such initial
allocation, upper-tier partnership must
next determine whether such specified
partner is a transferee described in
proposed § 1.163(j)–6(j)(6)(ii)(B). If it is,
then any deduction for such UTP BIE is
not disallowed under proposed
§ 1.163(j)–6(j)(8)(i). However, if the
specified partner is not a transferee
described in proposed § 1.163(j)–
6(j)(6)(ii)(B), then it is a transferee
specified partner, as defined in
proposed § 1.163(j)–6(j)(8)(i). As a
result, any deduction for such UTP BIE
is disallowed under proposed § 1.163(j)–
6(j)(8)(i). If there are multiple tiers of
partnerships, each tier must apply these
rules.
Finally, proposed § 1.163(j)–6(j)(8)(iii)
would provide a similar mechanism to
proposed § 1.163(j)–6(j)(8)(i) for
disallowing basis addbacks under
§ 1.163(j)–6(h)(3) for certain UTP EBIE.
Specifically, proposed § 1.163(j)–
6(j)(8)(iii) would provide that no basis
increase under proposed § 1.163(j)–
6(j)(5)(ii) shall be allowed to upper-tier
partnership for any disallowed UTP
EBIE. For purposes of § 1.163(j)–6, the
term disallowed UTP EBIE refers to any
UTP EBIE that has a specified partner
that is a transferee specified partner (as
defined in proposed § 1.163(j)–6(j)(8)(i))
and any UTP EBIE that does not have
a specified partner (as the result of a
transaction described in proposed
§ 1.163(j)–6(j)(6)(ii)(A)). For purposes of
applying proposed § 1.163(j)–6(j)(5)(ii),
upper-tier partnership shall treat any
disallowed UTP EBIE in the same
manner as UTP EBIE that has previously
been allocated a negative section 734(b)
adjustment. However, upper-tier
partnership does not treat disallowed
UTP EBIE as though it were allocated a
negative section 734(b) adjustment
pursuant to this paragraph to the extent
a negative section 734(b) or 743(b)
adjustment was previously made to
such disallowed UTP EBIE.
5. Foundational Determinations
In general, the rules under proposed
§ 1.163(j)–6(j) are derived from the
following three foundational
determinations made by the Treasury
Department and the IRS. First, basis is
preserved when upper-tier partnership
exchanges basis in its lower-tier
partnership for EBIE allocated from
lower-tier partnership (UTP EBIE).
Thus, upper-tier partnership generally
must treat UTP EBIE in the same
manner as built-in loss property.
Second, UTP EBIE has two
components—a basis component and a
carryforward component. In general,
negative basis adjustments under
section 734(b) and 743(b) reduce the
basis component of UTP EBIE (and thus,
any possible deduction for UTP EBIE),
but do not reduce the carryforward
component of UTP EBIE; only the two
conversion events in proposed
§ 1.163(j)–6(j)(5) are capable of reducing
the carryforward component of UTP
EBIE. Third, upper-tier partnership
must allocate any business interest
expense that was formerly UTP EBIE to
its specified partner—that is, the partner
that reduced its section 704(b) capital
account at the time of the initial
allocation of the UTP EBIE from lower-
tier partnership to upper-tier
partnership. If there is a transfer of a
partnership interest, the transferor
generally steps into the shoes of the
transferee’s status as specified partner,
but may not deduct any business
interest expense derived from the
transferor’s share of UTP EBIE.
The Treasury Department and the IRS
request comments on this approach.
Specifically, the Treasury Department
and the IRS request comments on
whether further guidance on the
treatment of UTP EBIE under the rules
of subchapter K of the Code is
necessary.
F. Partner Basis Adjustments Upon a
Distribution
Under the 2018 Proposed Regulations,
if a partner disposed of all or
substantially all of its partnership
interest, the adjusted basis of the
partnership interest was increased
immediately before the disposition by
the entire amount of the EBIE not
previously treated as paid or accrued by
the partner. If a partner disposed of less
than substantially all of its interest in a
partnership, the partner could not
increase its basis by any portion of the
EBIE not previously treated as paid or
accrued by the partner. The Treasury
Department and the IRS requested
comments on this approach in the
preamble to the 2018 Proposed
Regulations.
As discussed in the preamble to Final
Regulations, commenters cited multiple
concerns with the approach adopted in
the 2018 Proposed Regulations and
recommended that the Final Regulations
adopt a proportionate approach. Under
such an approach, a partial disposition
of a partnership interest would trigger a
proportionate EBIE basis addback and
corresponding decrease in such
partner’s EBIE carryover. The Treasury
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Department and the IRS agreed with
commenters. Accordingly, § 1.163(j)–
6(h)(3) provides for a proportionate
approach.
In general, a distribution from a
partnership is either a current
distribution or a liquidating
distribution; the concept of a
redemptive distribution does not exist
in the partnership context. Accordingly,
proposed § 1.163(j)–6(h)(4) would
provide that, for purposes of § 1.163(j)–
6(h)(3), a disposition includes a
distribution of money or other property
by the partnership to a partner in
complete liquidation of the partner’s
interest in the partnership. Proposed
§ 1.163(j)–6(h)(4) would further provide
that, for purposes of § 1.163(j)–6(h)(3), a
current distribution of money or other
property by the partnership to a
continuing partner is not a disposition
for purposes of § 1.163(j)–6(h)(3). The
Treasury Department and the IRS
request comments on whether a current
distribution of money or other property
by the partnership to a continuing
partner as consideration for an interest
in the partnership should also trigger an
addback and, if so, how to determine
the appropriate amount of the addback.
G. Allocable ATI and Allocable Business
Interest Income of Upper-Tier
Partnership Partners
Section 1.163(j)–6(f)(2) provides an
eleven-step computation necessary for
properly allocating a partnership’s
deductible BIE and section 163(j) excess
items among its partners. Pursuant to
§ 1.163(j)–6(f)(2)(ii), a partnership must
determine each of its partner’s allocable
share of each section 163(j) item under
section 704(b) and the regulations under
section 704 of the Code, including any
allocations under section 704(c), other
than remedial items. Further, § 1.163(j)–
6(f)(2)(ii) provides that the term
allocable ATI means a partner’s
distributive share of the partnership’s
ATI (that is, a partner’s distributive
share of gross income and gain items
comprising ATI less such partner’s
distributive share of gross loss and
deduction items comprising ATI), and
the term allocable business interest
income means a partner’s distributive
share of the partnership’s business
interest income.
In general, if a partnership is not a
partner in a partnership, each dollar of
taxable income that is properly allocable
to a trade or business will have a
corresponding dollar of ATI associated
with it. Accordingly, in the non-tiered
partnership context, if a partner’s share
of gross income and gain items
comprising ATI less such partner’s
share of gross loss and deduction items
comprising ATI equals $1, such partner
will have $1 of allocable ATI for
purposes of § 1.163(j)–6(f)(2)(ii).
However, if a partnership is a partner
in a partnership, each dollar of taxable
income that is properly allocable to a
trade or business may not have a full
dollar of ATI associated with it. Section
163(j)(4)(A)(ii)(I) provides that the ATI
of a partner in a partnership is
determined without regard to such
partner’s distributive share of any items
of income, gain, deduction, or loss of
such partnership. Further, section
163(j)(4)(A)(ii)(II) provides that a partner
only increases its ATI by its distributive
share of a partnership’s ETI.
To illustrate, consider the following
example. LTP has $100 of income and
$100 of loss properly allocable to a trade
or business. Thus, LTP has $0 of ATI.
LTP specially allocates the $100 of
income to partner UTP. Under section
163(j)(4)(A)(ii)(I), UTP does not treat
such $100 of income as ATI.
Additionally, UTP has $300 of income
properly allocable to a trade or business,
which UTP properly treats as ATI. Here,
UTP’s taxable income that is properly
allocable to a trade or business ($400)
does not equal the amount of its ATI
($300).
The Treasury Department and the IRS
recognize that a special rule is necessary
to coordinate situations like the one
illustrated earlier with the general
requirement under § 1.163(j)–6(f)(2)(ii)
for partnerships to determine a partner’s
allocable ATI based on such partner’s
allocation of items comprising the ATI
of the partnership. Accordingly,
proposed § 1.163(j)–6(j)(9) would
provide that, when applying § 1.163(j)–
6(f)(2)(ii), an upper-tier partnership
determines the allocable ATI and
allocable business interest income of
each of its partners in the manner
provided in proposed § 1.163(j)–6(j)(9).
Specifically, if an upper-tier
partnership’s net amount of tax items
that comprise (or have ever comprised)
ATI is greater than or equal to its ATI,
upper-tier partnership applies the rules
in paragraph (j)(9)(ii)(A) to determine
each partner’s allocable ATI. However,
if an upper-tier partnership’s net
amount of tax items that comprise (or
have ever comprised) ATI is less than its
ATI, upper-tier partnership applies the
rules in proposed § 1.163(j)–6(j)(9)(ii)(B)
to determine each partner’s allocable
ATI. To determine each partner’s
allocable business interest income, an
upper-tier partnership applies the rules
in proposed § 1.163(j)–6(j)(9)(iii).
H. Qualified Expenditures
The 2018 Proposed Regulations
provided that partnership ATI is
reduced by deductions claimed under
sections 173 (relating to circulation
expenditures), 174(a) (relating to
research and experimental
expenditures), 263(c) (relating to
intangible drilling and development
expenditures), 616(a) (relating to mine
development expenditures), and 617(a)
(relating to mining exploration
expenditures) (collectively ‘‘qualified
expenditures’’). As a result, deductions
for qualified expenditures reduced the
amount of business interest expense a
partnership could potentially deduct.
A partner may elect to capitalize its
distributive share of any qualified
expenditures of a partnership under
section 59(e)(4)(C) or may be required to
capitalize a portion of its distributive
share of certain qualified expenditures
of a partnership under section 291(b).
As a result, the taxable income reported
by a partner in a taxable year
attributable to the ownership of a
partnership interest may exceed the
amount of taxable income reported to
the partner on a Schedule K–1.
Commenters on the 2018 Proposed
Regulations recommended that a
distributive share of partnership
deductions capitalized by a partner
under section 59(e) or section 291(b)
increase the ATI of the partner because
qualified expenditures reduce both
partnership ATI and excess taxable
income, but may not reduce the taxable
income of a partner. Two different
approaches for achieving this result
were suggested: (1) Adjust the excess
taxable income of the partnership,
resulting in an increase to partner ATI,
and (2) increase the ATI of the partner
directly, without making any
adjustments to partnership excess
taxable income.
The Treasury Department and IRS
agree that a distributive share of
partnership deductions capitalized by a
partner under section 59(e) should
increase the ATI of the partner and
adopt the recommended approach of
increasing the ATI of the partner
directly, without making any
adjustments to partnership excess
taxable income. The approach of
increasing partner ATI by adjusting
partnership excess taxable income is
rejected, as it would result in
partnerships with more excess taxable
income than ATI—a result not possible
under the current statutory conceptual
framework. The Treasury Department
and IRS have the authority to adjust
ATI, but do not have a similar grant of
authority to make adjustments to
partnership excess taxable income,
which is explicitly defined by statute.
Accordingly, proposed § 1.163(j)–
6(e)(6) would provide that the ATI of a
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partner is increased by the portion of
such partner’s allocable share of
qualified expenditures (as defined in
section 59(e)(2)) to which an election
under section 59(e) applies. Any
deduction allowed under section
59(e)(1) would be taken into account in
determining a partner’s ATI pursuant to
§ 1.163(j)–1(b). Proposed §1.163(j)–
6(l)(4)(iv) would provide a similar rule
in the S corporation context.
The Treasury Department and IRS are
aware that a similar issue exists in the
context of depletion and request
comments as to whether a similar
partner level add-back is appropriate.
The Treasury Department and IRS are
also aware that a partner may be
required to capitalize certain qualified
expenditures of a partnership under
section 291(b) and request comments as
to whether a similar partner level add-
back is appropriate.
I. CARES Act Partnership Rules
As stated in the Background section of
this preamble, section 163(j)(10), as
enacted by the CARES Act, provides
special rules for partners and
partnerships for taxable years beginning
in 2019 or 2020. Under sections
163(j)(10)(A)(i) and 163(j)(10)(A)(ii)(I),
for partnerships, the amount of business
interest that may be deductible under
section 163(j)(1) for taxable years
beginning in 2020 is computed using
the 50 percent ATI limitation. The 50
percent ATI limitation does not apply to
partnerships for taxable years beginning
in 2019. See section 163(j)(10)(A)(ii)(I).
Under section 163(j)(10)(A)(iii), a
partnership may elect to not apply the
50 percent ATI limitation and, instead,
to apply the 30 percent ATI limitation.
This election is made by the
partnership.
Under section 163(j)(10)(A)(ii)(II), a
partner treats 50 percent of its allocable
share of a partnership’s excess business
interest expense for 2019 as a business
interest expense in the partner’s first
taxable year beginning in 2020 that is
not subject to the section 163(j)
limitation (50 percent EBIE rule). The
remaining 50 percent of the partner’s
allocable share of the partnership’s 2019
excess business interest expense
remains subject to the section 163(j)
limitation applicable to excess business
interest expense carried forward at the
partner level. A partner may elect out of
the 50 percent EBIE rule. Proposed
§ 1.163(j)–6(g)(4) provides further
guidance on the 50 percent EBIE rule.
Additionally, section 163(j)(10)(B)(i)
allows a taxpayer to elect to substitute
its 2019 ATI for the taxpayer’s 2020 ATI
in determining the taxpayer’s section
163(j) limitation for any taxable year
beginning in 2020. Section 1.163(j)–
2(b)(3) and (4) of the Final Regulations
provide general rules regarding this
election. Proposed § 1.163(j)–6(d)(5)
provides further guidance on this
election in the partnership context. The
Treasury Department and the IRS
request comments on these proposed
rules and on whether further guidance
is necessary.
V. Proposed § 1.163(j)–7: Application of
the Section 163(j) Limitation to Foreign
Corporations and United States
Shareholders
Proposed § 1.163(j)–7 in these
Proposed Regulations (Proposed
§ 1.163(j)–7) provides general rules
regarding the application of the section
163(j) limitation to foreign corporations
and U.S. shareholders of CFCs. This
section V describes proposed § 1.163(j)–
7 contained in the 2018 Proposed
Regulations, the comments received on
proposed § 1.163(j)–7 contained in the
2018 Proposed Regulations, and
Proposed § 1.163(j)–7.
A. Overview of Proposed § 1.163(j)–7
Contained in the 2018 Proposed
Regulations
1. General Application of Section 163(j)
Limitation to Applicable CFCs
The 2018 Proposed Regulations
clarify that, consistent with § 1.952–2,
section 163(j) and the section 163(j)
regulations apply to determine the
deductibility of an applicable CFC’s BIE
in the same manner as these provisions
apply to determine the deductibility of
a domestic C corporation’s BIE. The
2018 Proposed Regulations define an
applicable CFC as a CFC in which at
least one U.S. shareholder owns stock
within the meaning of section 958(a).
However, in certain cases, the 2018
Proposed Regulations allow certain
applicable CFCs to make a CFC group
election and be treated as part of a CFC
group for purposes of computing the
applicable CFC’s section 163(j)
limitation.
2. Limitation on Amount of Business
Interest Expense of a CFC Group
Member Subject to the Section 163(j)
Limitation
Under the 2018 Proposed Regulations,
if a CFC group election is in effect, the
amount of BIE of a CFC group member
that is subject to the section 163(j)
limitation is limited to the amount of
the CFC group member’s allocable share
of the CFC group’s applicable net BIE
(which is equal to the sum of the BIE of
all CFC group members, reduced by the
BII of all CFC group members). Thus, for
example, if a CFC group has no debt
other than loans between CFC group
members, no portion of the BIE of a CFC
group member would be subject to the
section 163(j) limitation. A CFC group
member’s allocable share is computed
by multiplying the applicable net BIE of
the CFC group by a fraction, the
numerator of which is the CFC group
member’s net BIE (computed on a
separate company basis), and the
denominator of which is the sum of the
amounts of the net BIE of each CFC
group member with net BIE (computed
on a separate company basis).
After applying the CFC group rules to
determine each CFC group member’s
allocable share of the CFC group’s
applicable net BIE, each CFC group
member that has BIE is required to
perform a stand-alone section 163(j)
calculation to determine whether any
BIE is disallowed under the section
163(j) limitation.
3. Membership in a CFC Group
Under the 2018 Proposed Regulations,
in general, a CFC group means two or
more applicable CFCs if at least 80
percent of the value of the stock of each
applicable CFC is owned, within the
meaning of section 958(a), by a single
U.S. shareholder or, in the aggregate, by
related U.S. shareholders that own stock
of each member in the same proportion.
The 2018 Proposed Regulations also
generally treat a controlled partnership
(in general, a partnership in which CFC
group members own, in the aggregate, at
least 80 percent of the interests) as a
CFC group member. For purposes of
identifying a CFC group, members of a
consolidated group are treated as a
single person, as are individuals filing a
joint return, and stock owned by certain
passthrough entities is treated as owned
proportionately by the owners or
beneficiaries of the passthrough entity.
The 2018 Proposed Regulations
exclude from the definition of a CFC
group member an applicable CFC that
has any income that is effectively
connected with the conduct of a trade
or business in the United States. In
addition, if one or more CFC group
members conduct a financial services
business, those entities are treated as
comprising a separate subgroup.
Under the 2018 Proposed Regulations,
a CFC group election is made by
applying the rules applicable to CFC
groups for purposes of computing each
CFC group member’s deduction for BIE.
Once made, the CFC group election is
irrevocable.
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1
Section 1.952–2(b) generally provides that the
taxable income for a foreign corporation is
determined by treating the foreign corporation as a
Continued
4. Roll-Up of CFC Excess Taxable
Income to Other CFC Group Members
and U.S. Shareholders
Under the 2018 Proposed Regulations,
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 any
‘‘CFC excess taxable income’’ of a lower-
tier CFC group 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, and, in general,
means the amount of a CFC group
member’s ATI in excess of the amount
needed to prevent any BIE of the CFC
group member from being disallowed
under section 163(j).
Under the 2018 Proposed Regulations,
a U.S. shareholder is not permitted to
include in its ATI amounts included in
gross income under section 951(a)
(subpart F inclusions), section 951A(a)
(GILTI inclusions), or section 78
(section 78 inclusions) that are properly
allocable to a non-excepted trade or
business (collectively, deemed income
inclusions). However, the 2018
Proposed Regulations provide that a
portion of CFC excess taxable income of
the highest-tier applicable CFC is
permitted to be used to increase the ATI
of its U.S. shareholders. That portion is
equal to the U.S. shareholder’s interest
in the highest-tier applicable CFC
multiplied by its specified ETI ratio.
The numerator of the specified ETI ratio
is the sum of the U.S. shareholder’s
income inclusions under sections 951(a)
and 951A(a) with respect to the
specified highest-tier member and
specified lower-tier members, and the
denominator is the sum of the taxable
income of the specified highest-tier
member and specified lower-tier
members.
B. Summary of Comments on Proposed
§ 1.163(j)–7 Contained in the 2018
Proposed Regulations
The Treasury Department and the IRS
requested comments in the preamble to
the 2018 Proposed Regulations
regarding whether it would be
appropriate to further modify the
application of section 163(j) to
applicable CFCs and whether there are
particular circumstances in which it
may be appropriate to exempt an
applicable CFC from the application of
section 163(j). Some commenters
recommended that section 163(j) not
apply to applicable CFCs. Those
comments are addressed in part VIII of
the Summary of Comments and
Explanation of Revisions section in the
Final Regulations.
A number of commenters broadly
requested changes to the roll-up of CFC
excess taxable income. Many of these
commenters expressed concern about
the administrability of rolling up CFC
excess taxable income. Some
commenters suggested that the CFC
group election be available to a stand-
alone applicable CFC in order to allow
its CFC excess taxable income to be
used to increase the ATI of a U.S.
shareholder, or that an applicable CFC
be permitted to use any CFC excess
taxable income to increase the ATI of a
shareholder without regard to whether it
is a CFC group member. Furthermore,
some commenters asserted that the
nature of the roll-up compels
multinationals to restructure their
operations in order to move CFCs with
relatively high amounts of ATI and low
amounts of interest expense to the
bottom of the ownership chain and
CFCs with relatively low amounts of
ATI and high amounts of interest
expense to the top of the ownership
chain, in order to maximize the benefits
of the roll-up of CFC excess taxable
income.
Some commenters asserted that
because multinational organizations
may own hundreds of CFCs, applying
the section 163(j) limitation on a CFC-
by-CFC basis, without regard to whether
a CFC group election has been made
under the 2018 Proposed Regulations,
represents a significant administrative
burden. Many comments suggested that
CFC groups should be permitted to
apply section 163(j) on a group basis,
with a single group-level section 163(j)
calculation similar to the rules
applicable to a consolidated group. A
few commenters suggested that this rule
should be applied in addition to the
roll-up of CFC excess taxable income,
but most commenters recommended
that the group rule be applied instead of
the roll-up.
A number of commenters asserted
that the requirements to be a member of
a CFC group under the 2018 Proposed
Regulations are overly restrictive. Some
of these commenters recommended that
the 80-percent ownership threshold be
replaced with the ownership
requirements of affiliated groups under
section 1504(a), the rules of which are
well-known and understood. Others
recommended that the 80-percent
ownership requirement be reduced to 50
percent, consistent with the standard for
treatment of a foreign corporation as a
CFC. Still others asserted that U.S.
shareholders owning stock in applicable
CFCs should not each be required to
own the same proportion of stock in
each applicable CFC in order for their
ownership interests to count towards
the 80-percent ownership requirement,
or that the attribution rules of section
958(b), rather than section 958(a),
should apply for purposes of
determining whether the ownership
requirements are met. Finally, some of
these commenters requested that a CFC
group election be permitted when one
applicable CFC meets the ownership
requirements for other applicable CFCs,
even if no U.S. shareholder meets the
ownership requirements for a highest-
tier applicable CFC.
Some commenters requested the CFC
financial services subgroups not be
segregated from the CFC group and their
BIE and BII be included in the general
CFC group.
Some commenters requested that an
applicable CFC with effectively
connected income be permitted to be a
member of a CFC group and that only
its effectively connected income items
should be excluded. Alternatively,
commenters requested a de minimis
rule that would permit an applicable
CFC to be a member of a CFC group if
the applicable CFC’s effectively
connected income is below a certain
threshold of total income, such as 10
percent.
Some commenters requested that the
CFC group election be revocable. The
commenters proposed either making the
CFC group election an annual election
or providing that the election applies for
a certain period, for example, three or
five years, before it can be revoked.
Finally, commenters requested a safe
harbor or exclusion providing that if a
CFC group would not be limited under
section 163(j) either because the CFC
group has no net BIE or because its BIE
does not exceed 30 percent of the CFC
group’s ATI, a U.S. shareholder would
not have to apply section 163(j) for the
applicable CFC or be subject to
applicable CFC section 163(j) reporting
requirements.
C. Proposed § 1.163(j)–7
1. Overview
As noted in the preamble to the Final
Regulations, the Treasury Department
and the IRS have determined, based on
a plain reading of section 163(j) and
§ 1.952–2, that section 163(j) applies to
foreign corporations where relevant
under current law and has applied to
such corporations since the effective
date of the new provision.
1
Congress
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domestic corporation but with certain enumerated
exceptions. Section 1.952–2(c) provides for a
number of exceptions, but none of the exceptions
affects the application of section 163(j).
2
For purposes of Proposed §1.163(j)–7, the term
effectively connected income (or ECI) means
income or gain that is ECI, as defined in §1.884–
1(d)(1)(iii), and deduction or loss that is allocable
to, ECI, as defined in §1.884–1(d)(1)(iii).
expressly provided that section 163(j)
should not apply to certain small
businesses or to certain excepted trades
or businesses. Nothing in the Code or
legislative history indicates that
Congress intended to except other
persons with trades or businesses, as
defined in section 163(j)(7), from the
application of section 163(j).
Accordingly, the Treasury Department
and the IRS have determined that,
consistent with a plain reading of
section 163(j) and § 1.952–2, it is
appropriate for section 163(j) to apply to
applicable CFCs and other foreign
corporations whose taxable income is
relevant for Federal tax purposes (other
than by reason of having ECI or income
described in section 881 (FDAP))
(relevant foreign corporations).
2
In the
case of CFCs with ECI, see proposed
§ 1.163(j)–8. For further discussion of
the Treasury Department and the IRS’s
determination that there is not a
statutory basis for exempting applicable
CFCs from the application of section
163(j), see part VIII of the Summary of
Comments and Explanation of Revisions
section of the Final Regulations.
A number of comments were received
asserting that there are other
mechanisms that eliminate the policy
need for section 163(j) to apply to limit
leverage in CFCs. For example, some
commenters have cited tax rules in
foreign jurisdictions limiting interest
deductions, including thin
capitalization rules (or similar rules
intended to implement the Organisation
for Economic Co-operation and
Development (OECD) recommendations
under Action 4 of the Base Erosion and
Profits Shifting Project). The Treasury
Department and the IRS disagree with
these assertions. The Treasury
Department and the IRS note that these
rules are not universally applied in
other jurisdictions, that many
jurisdictions do not have any
meaningful interest expense limitation
rules, and that some jurisdictions have
no interest expense limitation rules of
any kind.
Even if some CFCs owned by a U.S.
shareholder are in foreign jurisdictions
with meaningful thin capitalization
rules, in the absence of section 163(j), it
would still be possible to use leverage
to reduce or eliminate a U.S.
shareholder’s global intangible low-
taxed income (GILTI) under section
951A for these CFCs. This is because for
purposes of computing a U.S.
shareholder’s GILTI under section 951A,
tested income of CFCs may be offset by
tested losses of CFCs owned by the U.S.
shareholder. See section 951A(c). The
ability to deduct interest without
limitation under section 163(j) would
result in tested losses in CFCs with
significant leverage. Because of this
aggregation, one overleveraged CFC in a
single jurisdiction that does not have
rules limiting interest expense can,
without the application of section
163(j), reduce or eliminate tested
income from all CFCs owned by a U.S.
shareholder regardless of jurisdiction.
Other comments suggested that, to the
extent that debt of a CFC is held by a
related party, transfer pricing principles
would discipline the amount of interest
expense. Comments also note that to the
extent that debt of a CFC is held by a
third party, market forces would
discipline the leverage present in the
CFC. While both of these concepts may
discipline the amount of leverage
present in a CFC, they would also
discipline the amount of leverage in any
entity. If Congress believed that market
forces and transfer pricing principles
were sufficient disciplines to prevent
overleverage, section 163(j) would not
have been amended as part of TCJA to
clearly apply to interest expense paid or
accrued to both third parties and related
parties. In addition, if transfer pricing
were sufficient to police interest
expense in the related party context, old
section 163(j) (as enacted in 1989 and
subsequently revised prior to TCJA)
would not have been necessary.
However, the Treasury Department
and the IRS also have determined that
it is appropriate, while still carrying out
the provisions of the statute and the
policies of section 163(j), to reduce the
administrative and compliance burdens
of applying section 163(j) to applicable
CFCs. Accordingly, Proposed § 1.163(j)–
7 allows for an election to be made to
apply section 163(j) on a group basis
with respect to applicable CFCs that are
‘‘specified group members’’ of a
‘‘specified group.’’ If the election is
made, the specified group members are
referred to as ‘‘CFC group members’’
and all of the CFC group members
collectively are referred to as a ‘‘CFC
group.’’ The rules for determining a
specified group and specified group
members are discussed in part V.C.3. of
this Explanation of Provisions section.
The rules and procedures for treating
specified group members as CFC group
members and for determining a CFC
group are discussed in part V.C.4. of this
Explanation of Provisions section.
In addition, Proposed § 1.163(j)–7
provides a safe harbor election that
exempts certain applicable CFCs from
application of section 163(j). The safe-
harbor election is available for stand-
alone applicable CFCs (which is an
applicable CFC that is not a specified
group member of a specified group) and
CFC group members. The election is not
available for an applicable CFC that is
a specified group member but not a CFC
group member because a CFC group
election is not in effect. See part V.C.7.
of this Explanation of Provisions
section.
Proposed § 1.163(j)–7 also provides an
anti-abuse rule that increases ATI in
certain circumstances.
Finally, Proposed § 1.163(j)–7 allows
a U.S. shareholder of a stand-alone
applicable CFC or a CFC group member
of a CFC group to include a portion of
its deemed income inclusions
attributable to the applicable CFC in the
U.S. shareholder’s ATI. This rule does
not apply with respect to an applicable
CFC that is a specified group member
but not a CFC group member because a
CFC group election is not in effect. See
part V.C.9. of this Explanation of
Provisions section.
The Treasury Department and the IRS
anticipate that, in many instances,
Proposed § 1.163(j)–7 will significantly
reduce the administrative and
compliance burdens of applying section
163(j) to applicable CFCs relative to the
2018 Proposed Regulations.
Unlike Proposed § 1.163(j)–8, which
provides rules for allocating disallowed
BIE to ECI and non-ECI, Proposed
§ 1.163(j)–7 does not allocate disallowed
BIE among classes of income. The
Treasury Department and the IRS
request comments on appropriate
methods of allocating disallowed BIE
among classes of income, such as
subpart F income, as defined in section
952, and tested income, as defined in
section 951A(c)(2)(A) and § 1.951A–
2(b)(1), as well as comments on whether
and the extent to which rules
implementing such methods may be
necessary.
In addition, the Treasury Department
and the IRS request comments on
appropriate methods of allocating
disallowed BIE for other purposes,
including between items described in
§ 1.163(j)–1(b)(22)(i) and other items
described in § 1.163(j)–1(b)(22) (defining
interest), as well as comments on
whether and the extent to which rules
implementing such methods may be
necessary.
The Treasury Department and the IRS
do not anticipate that section 163(j) will
affect the tax liability of a passive
foreign investment company, within the
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For example, assume a U.S. multinational group
parented by a consolidated group with a taxable
year that is the calendar year includes applicable
CFCs with November 30 taxable years and other
applicable CFCs with calendar year taxable years.
In this case, as discussed in more detail in part
V.C.3.b. of the Explanation of Provisions section,
the specified period of the CFC group for 2020
would begin on January 1, 2020, and end on
December 31, 2020. Furthermore, the specified
taxable year of a CFC group member with a taxable
year that is the calendar year is its taxable year
ending December 31, 2020, and the specified
taxable year of a CFC group member with a
November 30 taxable year is its taxable year ending
November 30, 2020 (the taxable years that end with
or within the specified period). A CFC group
member can also have multiple taxable years with
respect to a specified period. For example, a CFC
group member may have a short taxable year due
to an election under §1.245A–5T(e)(3)(i) (elective
exception to close a CFC’s taxable year in the case
of an extraordinary reduction).
meaning of section 1297(a) (PFIC), or its
shareholders, solely because the PFIC is
a relevant foreign corporation. See
§ 1.163(j)–4(c)(1) (providing that section
163(j) does not affect earnings and
profits). The Treasury Department and
the IRS request comments on whether
any additional guidance is needed to
reduce the compliance burden of
section 163(j) on PFICs and their
shareholders.
2. Application of Section 163(j) to CFC
Group Members
a. Single Section 163(j) Limitation for a
CFC Group
Proposed § 1.163(j)–7(c) provides
rules for applying section 163(j) to CFC
group members of a CFC group. Under
the Proposed Regulations, a single
section 163(j) limitation is computed for
a CFC group. See proposed § 1.163(j)–
7(c)(2). For this purpose, the current-
year BIE, disallowed BIE carryforwards,
BII, floor plan financing interest
expense, and ATI of a CFC group are
equal to the sums of the current-year
amounts of such items for each CFC
group member for its specified taxable
year with respect to the specified
period. (The terms ‘‘specified taxable
year’’ and ‘‘specified period’’ are
discussed in part V.C.3. of this
Explanation of Provisions section.) A
CFC group member’s current-year BIE,
BII, floor plan financing interest
expense, and ATI for a specified taxable
year are generally determined on a
separate-company basis before being
included in the CFC group calculation.
b. Allocation of CFC Group’s Section
163(j) Limitation to Business Interest
Expense of CFC Group Members
The extent to which a CFC group’s
section 163(j) limitation is allocated to
a particular CFC group member’s
current-year BIE and disallowed BIE
carryforwards is determined using the
rules that apply to consolidated groups
under § 1.163(j)–5(a)(2) and (b)(3)(ii)
(consolidated BIE rules), subject to
certain modifications. See proposed
§ 1.163(j)–7(c)(3)(i). Because many CFC
groups will be owned by consolidated
groups, many taxpayers will be familiar
with the consolidated BIE rules.
If the sum of the CFC group’s current-
year BIE and disallowed BIE
carryforwards exceeds the CFC group’s
section 163(j) limitation, then current-
year BIE is deducted first. If the CFC
group’s current-year BIE exceeds the
CFC group’s section 163(j) limitation,
then each CFC group member deducts
the amount of its current-year BIE not in
excess of the sum of its BII and floor
plan financing interest expense, if any.
Then, if the CFC group has any section
163(j) limitation remaining for the
current year, each applicable CFC with
remaining current-year BIE deducts a
pro rata portion thereof.
If the CFC group’s section 163(j)
limitation exceeds its current-year BIE,
then CFC group members may deduct
all of their current-year BIE and may
deduct disallowed BIE carryforwards
not in excess of the CFC group’s
remaining section 163(j) limitation. The
disallowed BIE carryforwards are
deducted in the order of the taxable
years in which they arose, beginning
with the earliest taxable year, and
disallowed BIE carryforwards that arose
in the same taxable year are deducted
on a pro rata basis. This taxable year
ordering rule is consistent with the
consolidated BIE rules. However,
Proposed § 1.163(j)–7 provides special
rules for disallowed BIE carryforwards
when CFC group members have
different taxable years, or a CFC group
member has multiple taxable years with
respect to the specified period of the
CFC group. Unlike members of a
consolidated group, not all CFC group
members will have the same taxable
years, and not all CFC group members
will have the same taxable year as the
parent of the CFC group. As discussed
in part V.C.3 of this Explanation of
Provisions section, a CFC group member
is included in a CFC group for its entire
taxable year that ends with or within a
specified period.
3
c. Limitation on Pre-Group Disallowed
Business Interest Expense
Carryforwards
The disallowed BIE carryforwards of
a CFC group member when it joins a
CFC group (pre-group disallowed BIE
carryforwards) are subject to the same
CFC group section 163(j) limitation and
are deducted pro rata with other CFC
group disallowed BIE carryforwards.
However, pre-group disallowed BIE
carryforwards are subject to additional
limitations, similar to the limitations on
deducting the disallowed BIE
carryforwards of a consolidated group
arising in a SRLY, as defined in
§ 1.1502–1(f), or treated as arising in a
SRLY under the principles of § 1.1502–
21(c) and (g). The policy of the
limitation imposed on pre-group BIE
carryforwards is analogous to the policy
of the SRLY limitation for consolidated
groups.
The rules and principles of § 1.163(j)–
5(d)(1)(B), which applies SRLY
subgroup principles to disallowed BIE
carryforwards of a consolidated group,
apply to pre-group subgroups. If a CFC
group member with pre-group
disallowed BIE carryforwards (loss
member) leaves one CFC group (former
group) and joins another CFC group
(current group), the loss member and
each other CFC group member that left
the former group and joined the current
group for a specified taxable year with
respect to the same specified period
consists of a ‘‘pre-group subgroup.’’
Unlike SRLY subgroups, it is not
required that all members of a pre-group
subgroup join the CFC group at the same
time, since each applicable CFC that
joins a CFC group is treated as joining
on the first day of its taxable year. As
a result, even if multiple applicable
CFCs are acquired on the same day in
a single transaction, they would join the
CFC group on different days if they have
different taxable years.
d. Special Rules for Specified Periods
Beginning in 2019 or 2020
Proposed § 1.163(j)–7(c)(5) provides
special rules for applying section
163(j)(10) to CFC groups. The proposed
regulations provide that elections under
section 163(j)(10) are made for a CFC
group (rather than for each CFC group
member). For a specified period of a
CFC group beginning in 2019 or 2020,
unless the election described in
§ 1.163(j)–2(b)(2)(ii)(A) is made, the CFC
group section 163(j) limitation is
determined by using 50 percent (rather
than 30 percent) of the CFC group’s ATI
for the specified period, without regard
to whether the taxable years of CFC
group members begin in 2019 or 2020.
If the election described in § 1.163(j)–
2(b)(2)(ii)(A) is made for a specified
period of a CFC group, the CFC group
section 163(j) limitation is determined
by using 30 percent (rather than 50
percent) of the CFC group’s ATI for the
specified period, without regard to
whether the taxable years of CFC group
members begin in 2019 or 2020. The
election is made for the CFC group by
each designated U.S. person.
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The election under § 1.163(j)–
2(b)(3)(i) to use 2019 ATI (that is, ATI
for the last taxable year beginning in
2019) rather than 2020 ATI (that is, ATI
for a taxable year beginning in 2020) is
made for a specified period of a CFC
group beginning in 2020 (2020 specified
period) and applies to the specified
taxable years of CFC group members
with respect to the 2020 specified
period. Accordingly, if a specified
taxable year of a CFC group member
with respect to a CFC group’s 2020
specified period begins in 2020, then
the election is applied to such taxable
year using the CFC group member’s ATI
for its last taxable year beginning in
2019. In some cases, the specified
taxable year of a CFC group member
with respect to a CFC group’s 2020
specified period will begin in 2019 or
2021. If the specified taxable year of the
CFC group member begins in 2019, then
the election is applied to such taxable
year using the CFC group member’s ATI
for its last taxable year beginning in
2018; if the specified taxable year of the
CFC group member begins in 2021, then
the election is applied to such taxable
year using the CFC group member’s ATI
for its last taxable year beginning in
2020.
For example, assume a CFC group has
two CFC group members, CFC1 and
CFC2, and has a specified period that is
the calendar year. CFC1 has a taxable
year that is the calendar year, and CFC2
has a taxable year that ends November
30. The election under § 1.163(j)–
2(b)(3)(i) is in effect for the specified
period beginning January 1, 2020, and
ending December 31, 2020 (which is the
2020 specified period). As a result, the
ATI of the CFC group for the 2020
specified period is determined by
reference to the specified taxable year of
CFC1 beginning January 1, 2019, and
ending December 31, 2019 (the last
taxable year beginning in 2019), and the
specified taxable year of CFC2
beginning December 1, 2018, and
ending November 30, 2019 (the last
taxable year beginning in 2018).
Alternatively, assume (i) the same
CFC group instead has a 2020 specified
period that begins on December 1, 2020,
and ends on November 30, 2021; (ii) in
2019 and 2020, CFC1 has a taxable year
that is the calendar year, but in 2021,
CFC1 has a short taxable year that
begins on January 1, 2021, and ends on
June 30, 2021; and (iii) CFC2 has a
taxable year ending November 30 (for all
years). Further assume that the election
under § 1.163(j)–2(b)(3)(i) is in effect for
the 2020 specified period. In this case,
the election applies to the specified
taxable year of CFC1 that begins on
January 1, 2020, and ends on December
31, 2020; the specified taxable year of
CFC1 that begins on January 1, 2021,
and ends on June 30, 2021; and the
specified taxable year of CFC2 that
begins on December 1, 2020, and ends
on November 30, 2021. As a result of the
election, the ATI of the CFC group for
the 2020 specified period is determined
by reference to the specified taxable
year of CFC1 beginning January 1, 2019,
and ending December 31, 2019, the
specified taxable year of CFC1
beginning January 1, 2020, and ending
December 31, 2020, and the specified
taxable year of CFC2 beginning
December 1, 2019, and ending
November 30, 2020.
If the election under § 1.163(j)–
2(b)(3)(i) to use 2019 ATI rather than
2020 ATI is made for a CFC group, the
CFC group’s ATI for the 2020 specified
period is determined by reference to the
2019 ATI of all CFC group members
(except to the extent that 2018 or 2020
ATI is used, as described earlier),
including any CFC group member that
joins the CFC group during the 2020
specified period. Therefore, a CFC
group’s ATI for the 2020 specified
period may be determined by reference
to a prior taxable year of a new CFC
group member even though the CFC
group member was not a CFC group
member in the prior taxable year. If a
CFC group member leaves the CFC
group during the 2020 specified period,
the ATI of the CFC group for the 2020
specified period is determined without
regard to the ATI of the departing CFC
group member.
As stated in the Background section of
this preamble, Revenue Procedure
2020–22 generally provides the time
and manner of making or revoking
elections under section 163(j)(10),
including elections with respect to
applicable CFCs. References in Revenue
Procedure 2020–22 to CFC groups and
CFC group members are to CFC groups
and applicable CFCs for which a CFC
group election is made under the 2018
Proposed Regulations. The rules
described in this part V.C.2.d of this
Explanation of Provisions section and
proposed § 1.163(j)–7(c)(5) modify the
application of Revenue Procedure 2020–
22 and the elections under section
163(j)(10) for CFC groups and applicable
CFCs for which a CFC group election is
made under Proposed § 1.163(j)–7.
Thus, for example, if a CFC group has
two designated U.S. persons that are
U.S. corporations, pursuant to proposed
§ 1.163(j)–7(c)(5), the election to not
apply the 50 percent ATI limitation to
the CFC group for a specified period
beginning in 2020 is made for the
specified period of the CFC group by
each designated U.S. person, and
pursuant to Revenue Procedure 2020–
22, section 6.01(2), the election to not
apply the 50 percent ATI limitation is
made by the each designated U.S.
person timely filing a Federal income
tax return, including extensions, using
the 30 percent ATI limitation for
purposes of determining the taxable
income of the CFC group.
For purposes of applying § 1.964–1(c),
the elections described in proposed
§ 1.163(j)–7(c)(5) are treated as if made
for each CFC group member. Thus, the
requirements to provide a statement and
written notice as provided under
§ 1.964–1(c)(3)(i)(B) and (C) apply.
3. Specified Groups and Specified
Group Members
a. In General
Proposed § 1.163(j)–7(d) provides
rules for determining a specified group
and specified group members. The
determination of a specified group and
specified group members is the basis for
determining a CFC group and CFC
group members. This is because a CFC
group member is a specified group
member of a specified group for which
a CFC group election is in effect, and a
CFC group consists of all the CFC group
members. See proposed § 1.163(j)–
7(e)(2).
b. Specified Group
Under proposed § 1.163(j)–7(d)(2), a
specified group includes one or more
chains of applicable CFCs connected
through stock ownership with a
specified group parent, but only if the