On 16 May 2023, the IRS Large Business and International (LB&I) division issued two practice units in relation to interest expense limitations for related party loans.

Interest Expense Limitation on Related Foreign Party Loans Under IRC 267(a)(3)

This Practice Unit examines the deductibility of interest expense under the provisions of IRC 267(a)(3).

Under this provision, interest expense attributable to bona fide debt between a USS (borrower) and its foreign parent (FP) or foreign affiliate (lender) is limited to interest considered paid under the cash method of accounting regardless of the taxpayer’s overall method of accounting. Essentially, USS is required to use the cash method of accounting with respect to this deduction. An amount owed to a related foreign person may not be deducted by USS until the amount is paid to the related foreign person. If an amount is not paid within the cash method of accounting, the deduction will be deferred until paid. This is often referred to as the matching principle. The matching principle matches the recognition of deductions with the related income in the same taxable year. Without the matching principle, a deduction could be taken while the corresponding income is deferred indefinitely.

IRC 267 addresses losses, expenses, and interest with respect to transactions between related taxpayers. The purpose underlying IRC 267(a) is to prevent related persons from using different methods of accounting for federal tax purposes in order to mismatch the timing of deductions/losses and inclusions inappropriately.

Interest Expense Limitation Under IRC 163(j) for Controlled Foreign Corporations Post-TCJA

IRC 163(j) was first enacted by the Omnibus Act of 1989. This code section and proposed regulations only applied to U.S. corporations or foreign corporations with effectively connected income (ECI) that pay interest to a related person not subject to U.S. tax and was reported on Form 8926. The Tax Cut Jobs Act (TCJA) of 2017 repealed and replaced the prior law effective for tax years beginning after December 31, 2017. The TCJA provision applies to domestic and certain foreign corporations.

The purpose of the provision is to limit the deductibility of interest. The TCJA IRC 163(j) limits the interest deduction, in general, for all trades or business including those held by individuals, partnerships, corporations and S corporations. The IRC 163(j) limitation is reported on Form 8990 attached to the U.S. tax return (or attached to Form 5471 for foreign corporations). This Practice Unit will concentrate on the rules as applied to controlled foreign corporations (CFCs).