New US Interest Expense Deduction Limitation
The US Tax Cuts and Jobs Act (enacted on December 22, 2017) repeals the
existing earnings-stripping rules (IRC section 163(j)) applicable to
interest paid to foreign related parties. These rules have been replaced
with a stricter rule, effective for tax years beginning after 2017,
that applies to all business taxpayers (unless the exceptions set out
below apply) and to all business interest. Thus, interest paid to both
domestic parties and unrelated foreign parties is now subject to
limitation. Ambiguities in the new provision are expected to be
addressed by future IRS guidance; future corrective legislation is also a
The business interest affected by the provision is defined as any
interest paid or accrued on indebtedness properly allocable to a trade
or business. Any amount treated as interest for tax purposes is treated
as interest for the purposes of the provision.
The new limitation does not apply to some small businesses—those that
have average annual gross receipts for the three-taxable-year period
ending with the prior tax year that do not exceed US$25 million. In
addition, some taxpayers (such as certain real estate businesses and
certain farming businesses) can elect not to have the interest expense
limitation apply; businesses making this election are required to use
the alternative depreciation system to depreciate certain property.
Subject to certain exceptions, interest expense that exceeds 30 percent
of the relevant business's adjusted taxable income will be disallowed.
Adjusted taxable income generally is a business's taxable income
computed without regard to
For tax years beginning before 2022, adjusted taxable income may be
thought of as analogous to EBITDA (earnings before interest, taxes,
depreciation, and amortization) calculated using tax principles; for
later tax years, it is analogous to EBIT (earnings before interest and
taxes) computed using tax principles.
any item of interest, gain, deduction, or loss that is not properly allocable to a trade or business;
business interest or business interest income;
the amount of any net operating loss deduction;
the 20 percent deduction for certain passthrough income; and
in the case of tax years beginning before January 1, 2022, any deduction allowable for depreciation, amortization, or depletion.
The provision applies to all businesses, regardless of organizational
form, and any disallowance or excess limitation will generally be
determined at the filer level (for example, at the partnership level
rather than the partner level). For a group of affiliated corporations
filing a consolidated tax return, the provision is applied at the
consolidated return filing level.
Any disallowed business interest will be carried forward indefinitely;
however, in the case of business interest that is not allowed as a
deduction to a partnership, special carryforward rules apply to
partners. The provision will also have an impact on mergers and
acquisitions. In particular, the amounts carried forward will be taken
into account in the case of certain corporate acquisitions described in
IRC section 381, and are subject to limitation under IRC section 382.
The new provision does not address the situation of interest expense
deductions denied under the previous regime that were deferred and
carried forward; those deductions may still be available. However, it is
unclear whether a corporation may treat the disallowed interest expense
as business interest paid or accrued in a year after the effective date
of the provision (January 1, 2018).
Finally, the provision applies only to the taxpayer's business interest
expense. Other existing rules governing interest deduction (IRC
sections 267 and 385) remain in place and can limit the amount of the
interest deduction allowed. The new legislation also introduces a base
erosion anti-abuse tax (BEAT) regime, which imposes a minimum tax based
on the difference between regular tax liability and alternative tax
liability computed without the benefit of certain base erosion payments
(such as interest payments). A US corporation subject to the new IRC
section 163(j) may also be subject to BEAT.
KPMG LLP, Montreal