Oh my darling, oh my darling, oh my darling, Clementine, You are lost and gone forever, dreadful sorrow, Clementine.
Drove the horses to the water, every morning just at nine. Hit her foot against a splinter, fell into the foaming brine.
– Popular American folk ballad1
The 2017 Tax Cuts and Jobs Act ("T.C.J.A.") amended subsection (j) of Code §163 to enact a brand-new version of the U.S. tax law's limitation on deductions claimed for business interest expense. The new version provides that a taxpayer's deduction is capped at 30% of its adjusted taxable income ("A.T.I.").2 This represents a radical departure from old Code §163(j), as it shifts the focus from preventing earnings stripping transactions to a hard cap on the income tax benefit arising from debt placed in a taxpayer's capital structure.
The old Code §163(j) evaluated deductibility based on two thresholds: a debt-toequity ratio and a 50% expense-to-A.T.I. ratio. Where the thresholds were exceeded, it disqualified interest expense deductions for related-party debt not subject to 30% Federal withholding tax, as well as third-party debt supported by related-party guarantees and certain R.E.I.T.-to-taxable-R.E.I.T.-subsidiary loans.3
It is worth noting that, in the Preamble to the new final Code §385 regulations, the I.R.S. cited to four aspects of the new-and-improved Code §163(j) as reducing the benefit of earnings stripping transactions, including its (i) elimination of the debtequity ratio safe harbor; (ii) reduction to net interest deductions' maximum share of A.T.I. from 50% to 30%; (iii) extension of the interest expense limitation to all interest, not just related-party; and (iv) elimination of excess limitation carryforwards under old the Code §163(j).4
1 Attributed to Percy Montrose in 1884, though sometimes also to Barker Bradford; it is commonly performed in the key of F major. A popular alternative version references ducklings instead of horses.
2 Pub. L. 115-97, §13301(a) (the 30% limitation is increased by taxpayer's business interest and floor plan financing interest income). Beginning in 2022, A.T.I. is computed without taking into account depreciation, amortization, and depletion, meaning that the effect of missing out on the exemption to the 30% limitation discussed herein will become more pronounced.
3 Regulations were proposed, but never finalized, under the prior Code §163(j) in 1991. See 56 Fed. Reg. 27907 (June 18, 1991). These are now withdrawn. New Code §163(j) is one aspect of U.S. tax reform that is consistent with broader efforts undertaken by many other countries pursuant to B.E.P.S. Action 4.
4 See T.D. 9880, 84 Fed. Reg. 59297-59302 (effective November 4, 2019, removing final Code §385 regulations enacted in October 2016).
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