French corporations that have made loans to their U.S. affiliates may be significantly and favorably affected by a recent U.S. Tax Court decision.
Under an existing regulation, a U.S. affiliate cannot deduct interest due to a non-U.S. related party until the interest is actually paid. The Tate & Lyle decision would invalidate this regulation for French multinationals because the U.S.-France Income Tax Treaty exempts interest income from tax. This court case allows the corresponding interest expense to be deducted on an accrual basis.
The interest deduction is not automatic, however, and there are different strategies to consider. Existing and planned intercompany loans to U.S. affiliates should be reviewed in light of the decision to determine the optimal approach for the group.
In general, a U.S. taxpayer cannot deduct accrued interest due to a non-U.S. related party until the interest is actually paid. The purpose of imposing the cash method of accounting for such interest is to "match" the deduction with the recognition of the interest income for U.S. tax purposes. The existing regulation applies even if the lender is not subject U.S. tax on the interest income under an applicable treaty.
In Tate & Lyle v. Commissioner (103 TC 14), the U.S. Tax Court invalidated the regulation to the extent it disallows a deduction for accrued but unpaid interest that would be exempt from U.S. tax under a treaty. Although U.S. taxpayers may rely on this case to deduct such interest, the decision is likely to be appealed, and it is not clear whether it will be upheld.
How soon the U.S. affiliate may start deducting accrued interest depends on whether intercompany loans are already in place. A U.S. borrower that has already deferred interest deductions on at least two tax returns will need to receive permission from the U.S. tax authorities before following Tate & Lyle. As the request is unlikely to be reviewed before the final appeal of Tate & Lyle, the question for these taxpayers is whether to request the method change now, or wait for a favorable appeal to do so.
Making the request now would allow the accrual method to be effective for an earlier tax year (even if approval of the request is delayed). This would accelerate both the deduction of current accrued interest expense and the deduction of the "catch up" amount (i.e. the interest expense previously accrued but not deducted). Waiting to request the method change would defer the deduction of these amounts.
Applying for a method change is more difficult if the taxpayer is under audit. Thus, the U.S. affiliate's current status with the U.S. tax authorities needs to be considered when evaluating the optimal timing of a method change request.
U.S. borrowers that have filed no more than one tax return consistent with the regulation may follow the Tate & Lyle decision without requesting permission from the U.S. tax authorities. However, if a return was filed, it would need to be amended. If Tate & Lyle ultimately is overturned, taxpayers using the accrual method would have to request permission to change to the cash method and would have to take into taxable income previously deducted interest that remains unpaid.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be brought about your specific circumstances. For additional information contact Claire Acard on +33 (1) 55 61 10 10. The members of ARCHIBALD ANDERSEN Association d'Avocats (S.G. Archibald and Arthur Andersen International) are registered with the Hauts-de-Seine Bar.
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