The American Institute of Certified Public Accountants (AICP) believes that the definition of interest in IRC Section 163(j) proposed regulations is too broad and should apply only to interest from transactions that involve debt. The definition in the proposed regulations goes beyond that to include amounts not related to debt instruments but that:
- affect the cost of a transaction, or
- are closely related to interest.
The AICPA believes that this definition is not warranted and overly burdensome to taxpayers. The AICPA stated its conclusion as part of a number of comments it issued on the proposed regulations for the Section 163(j) deduction limit on business interest.
Business Interest Deduction Limit
A taxpayer’s deduction of business interest expenses paid or incurred for tax years beginning after 2017 is limited to the sum of:
- the taxpayer’s business interest income for the tax year,
- 30 percent of the taxpayer’s adjusted taxable income (ATI), and
- the taxpayer’s floor plan financing interest.
Any disallowed business interest is carried forward indefinitely. The limit applies to all taxpayers except a small business with average gross receipts in the prior-three year period of $25 million or less ($26 million for 2019). It also does not apply to a trade or business providing services as an employee, real property or farming businesses that make an election out, and certain regulated utility businesses.
Definition of Interest Under Regs.
The statutory language provides that business interest expense for purposes of Section 163(j) limit is any interest expense that is properly allocable to a trade or business of the taxpayer for the tax year. It also includes any disallowed business interest carryforward from a previous tax year. It does not include investment interest in the case of a non-corporate taxpayer.
Under the proposed regulations, interest is defined as:
- any amount paid, received, or accrued as compensation for the use or forbearance of money under the terms of a contract or instrument that is treated as debt;
- any amount closely related to interest and that affects the economic yield or cost of funds of a transaction involving interest (e.g., debt issuance costs, commitment fees, etc.); and
- other amounts predominantly associated with the time-value of money (i.e., anti-avoidance rule).
The Preamble to the proposed regulations state that this definition is designed to encompass all transactions that are commonly understood to generate interest. Thus, they go beyond the language of Section 163(j) to include payments that are not made with respect to a debt instruments to prove certainty and to avoid incentivize taxpayers from entering into distortive transactions.
‘Extremely Broad’ Definition
The AICPA believes that the definition of interest is ‘exceptionally broad’ in comments to the IRS on the proposed regulations. It recommends that the proposed rules be amended to define interest as any amount generally treated as interest under other provisions of the Code or regulations.
The AICPA argues that Section 163(j) does not present any special policy consideration that warrants defining interest more broadly than for other federal tax purposes (e.g., withholding and information reporting, foreign tax credit). Also, there is nothing in legislative history for Section 163(j) to indicate that Congress intended to expand the definition of interest to transactions that do not involve indebtedness.
The Preamble to the proposed regulations states that treating amounts that are closely related to interest is not new. This occurs in the Reg. §1.861-9T regarding the allocation and apportionment of interest expenses and in Reg. §1.954-2 regarding foreign personal holding company income of a controlled foreign corporation.
Related to Debt?
The AICPA argued that the underlying statute for these regulations have a different purpose than Section 163(j). The purpose of Section 163(j) is to limit the deduction of interest under Section 163(a). A taxpayer is generally allowed a deduction under Section 163(a) only for interest paid or accrued in the tax year on indebtedness.
The term indebtedness is not defined in the IRC or regulations. However, under case law and other guidance deductible interest under Section 163(a) generally must pertain to the debt of taxpayer and result from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money.
According to the AICPA, interest for Section 163(j) should be similarly defined. Alternatively, it recommends that the regulations should allow for an item-by-item in order to determine if any amount is interest for Section 163(j) purposes to be consistent with federal tax policy.
By John Buchanan, JD, LLM