
James F. McDonough
Of Counsel
732-568-8360 jmcdonough@sh-law.comFirm Insights
Author: James F. McDonough
Date: January 21, 2014
Of Counsel
732-568-8360 jmcdonough@sh-law.comChief Counsel Advice 201336018 (CCA) addresses such a situation in a U.S. consolidated group setting. The facts in the CCA are a U.S. parent corporation (P) owned all of the shares of two U.S. corporations (US-1 and US-2). P loaned US-1 funds that US-1 re-loaned to US-2. US-2 then transferred these funds down its chain of foreign subsidiary companies to finance the acquisition of foreign assets.
The terms of the loan agreement gave US-2 the option to pay interest either in currency baws on a LIBOR formula or in units of a foreign limited partnership (“FLP”) that is treated as a corporation for U.S. tax purposes. Internal Revenue Code §163(l) disallows a deduction for interest paid or accrued using equity and classifies the equity as “disqualified debt.” Payment of interest other than in currency impacts the U.S. consolidated return and the calculation of the foreign tax credit. Unfortunately, the impact can be different.
The consolidated return rules treat the non-deductible interest paid to the recipient as tax-exempt interest and the basis in the stock of the subsidiary is increased by the payment. No doubt the author of the CCA considered the possibility of inflating basis using FLP units to make payments. If that were to occur, the basis in the stock of the subsidiary would be overstated without a basis adjustment to accommodate the goal of §163(l). Unfortunately, these rules treat tax-exempt interest and interest on disqualified debt for purposes differently for purposes of the basis adjustment.
The next complication comes from the impact of basis adjustments upon the calculation of the foreign tax credit (FTC). Simply stated, the FTC is limited to the U.S. tax that would be imposed upon foreign source income. In order to calculate foreign source income, we must deduct (a) those expenses and losses which can be definitely allocated. and (b) then deduct a ratable allocation of other expenses which cannot be definitely allocated. Interest cannot be definitely allocated because it is considered fungible. Rather, interest is allocated between domestic and foreign source income on the basis of either income or assets, using either fair market value or tax book basis.
The taxpayer in the CCA took the position that the interest disallowed also requires the basis in the shares of the foreign company to be reduced to maintain consistency with the consolidated return rule.
What was at stake for the taxpayer?
The reduction in the basis of foreign asset (FLP units) would reduce the basis of foreign assets that would receive an allocation of interest. A lesser allocation of interest would increase foreign source net income and the foreign tax credit limitation. The higher limitation would increase the foreign tax credit available to offset U.S. income tax.
The regulation under 1.861-12T(f) permits the reduction of basis for purposes of the allocation where the basis of the asset is funded by disallowed interest. The CCA concludes that the taxpayer did not satisfy the “in connection with” requirement. The CCA stated that the provision of the loan agreement permitting payment in the form of stock was gratuitous .
Clearly, the Service’s view limits the use of the exceptions under 1.861-12T. The CCA reduces the taxpayer’s ability to increase its FTC which increases its tax bill. It is unclear whether the CCA will be challenged by taxpayer in an administrative appeal of any assessment or in Tax Court.
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
NYC Real Estate and Litigation Attorney Ryan O. Miller and Team Join Scarinci Hollenbeck, LLC New York City, NY – August 13, 2025 – Scarinci Hollenbeck, LLC has strengthened its Real Estate and Litigation practices with the addition of four New York City-based attorneys. Ryan Miller, who joins as a partner, is well known for […]
Author: Scarinci Hollenbeck, LLC
Business law plays a critical role in nearly every aspect of running a successful enterprise, from negotiating a commercial lease to drafting employee policies to fulfilling corporate disclosure obligations. Understanding what is business law and your legal obligations can help your business run smoothly and build productive relationships with clients, business partners, regulators, and others. […]
Author: Dan Brecher
Corporate transactions can have significant implications for a corporation and its stakeholders. For deals to be successful, companies must act strategically to maximize value and minimize risk. It is also important to fully understand the legal and financial ramifications of corporate transactions, both in the near and long term. Understanding Corporate Transactions The term “corporate […]
Author: Dan Brecher
Ongoing economic uncertainty is forcing many companies to make tough decisions, which includes lowering staff levels. The legal landscape on both the state and federal level also continues to evolve, especially with significant changes to the priorities of the Equal Employment Opportunity Commission (“EEOC”) under the Trump Administration. Terminating an employee is one of the […]
Author: Angela A. Turiano
While filing annual reports may seem like a nuisance, failing to do so can have significant ramifications. These include fines, reputational harm, and interruption of your business operations. In basic terms, “admin dissolution for annual report” means that a company is dissolved by the government. This happens because it failed to submit its annual report […]
Author: Dan Brecher
Antitrust laws are designed to ensure that businesses compete fairly. There are three federal antitrust laws that businesses must navigate. These include the Sherman Act, the Federal Trade Commission Act, and the Clayton Act. States also have their own antitrust regimes. These may vary from federal regulations. Understanding antitrust litigation helps businesses navigate these complex […]
Author: Robert E. Levy
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!