The National Multistate Tax Symposium WestMove forward with confidence—State implications of tax reform
April 30-May 2, 2018
Debt-related considerations arising from federal tax reformConrad Krol, Deloitte Tax LLPAlexis Morrison-Howe, Deloitte Tax LLP
May 1, 2018
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• Section 163(j) Overview
o Corporate Considerations
o Partnership Considerations
• State and Local Considerations
• Effects of 2017 Tax Reform Act on Debt Issuance
Agenda
4
Section 163(j)
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2017 Tax Reform Act ChangesSection 163(j) Interest Limitation
• Major Changes
o Repealed prior section 163(j) limitations on the deductibility of a corporation’s interest expense for interest paid to a related person that is not subject to U.S. tax (e.g., a foreign parent).
o Replaced prior rules with new section 163(j), which now potentially limits deductions for all business interest – paid to related and unrelated parties
• Applicability
o New section 163(j) applies to limit the deduction for “business interest” of all “taxpayers” (section 163(d) separately applies to investment interest).
o Partnerships – the limitation is applied at the partnership level with rules intended to preclude potential double counting by partners (S corporations treated similarly).
o Corporations
• Effective for taxable years beginning after December 31, 2017.
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Business Interest Expense LimitationsSection 163(j) (cont.)
• “Business interest” is defined as interest on indebtedness that is properly allocable to a trade or business.
o Legislative history suggests that all of a corporation’s interest expense is “business interest.”
• The deduction for “business interest” for any year is limited to the sum of:
o “Business interest income” – not including investment interest
o 30% of the business’s “adjusted taxable income” (“ATI”); and
o floor plan financing interest (“FPFI”), defined in section 163(j)(9) generally as interest expense related to the acquisition of motor vehicles, including boats and farm equipment, for sale or lease.
• “ATI” means the taxable income of the taxpayer, but excludes:
o items of income, gain, deduction, or loss not properly allocable to a trade or business,
o business interest expense or income,
o net operating loss deductions under section 172,
o deductions allowed under section 199A, and
o only for tax years beginning before January 1, 2022, depreciation, amortization, or depletion deductions.
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Business Interest Expense Limitations Other Considerations
• Any disallowed interest deductions can be carried forward indefinitely, subject to the rules of Section 381
o Carryforward would be treated as a section 381(c) attribute and as a “pre-change loss” for purposes of section 382(d).
o Consider possible interaction between the carryforward of disallowed business interest expense and NOLs.
• Exemptions, at the taxpayer’s election, for real estate and farming businesses and automatic exemptions for certain public utilities, retail floor planning indebtedness, small business, and for interest allocable to performing services as an employee.
• Section 385 regulations – Treasury had indicated that they intended to re-evaluate need for Treas. Reg. §§ 1.385-3, -3T, and -4T in light of the federal 2017 Tax Reform Act (the “Act”). Query whether Treasury will remove these regulations.
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Business Interest Expense Limitations - NOLs and Disallowed Interest Expense
Disallowed interest expense under section 163(j) is a tax attribute similar to an NOL.
NOLs New Section 163(j) Disallowed Interest
C/F and C/B Periods
Under the Act, generally indefinite carryforward and no carryback (exception for P&C insurance companies).
Indefinite carryforward and no carryback. Acarryforward of disallowed interest treated as paid or accrued in succeeding tax year.
Utilization Under the Act, can offset 80% of taxable income (exception for P&C insurance companies).
Can offset 100% of taxable income.
Treatment as attribute
NOLs treated as attribute under section 381(c) subject to applicable limitations.
Disallowed interest treated as section 381(c)attribute (new section 381(c)(20)).
Section 382 Section 382 applies (and on consolidated / subgroup basis under consolidated return regulations).
Section 163(j) disallowed interest treated as a pre-change loss under section 382(d) (new section 382(d)(3)).
NOTE: Under prior section 163(j), it was neither explicit nor clear if and how section 382 applied to
disallowed interest (proposed regulations simply referred to the section 382 rules on built-in
deductions). If prior disallowed interest is carried into the new regime, it appears to be treated as paid
or accrued in the tax year subject to new section 163(j). Query whether such an attribute is now
subject to section 382 and the effect of prior ownership changes.
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Business Interest Expense LimitationsPartnership Rules
• The 30% Business Interest Limit is applied at the partnership level.
• A partner’s distributive share is not included in determining such partner’s own ATI under the new rules. However, each partner’s own ATI is increased by the partner’s distributive share of the partnership’s “excess taxable income.”
• Excess Taxable Income equals:
• To the extent that a partnership has disallowed Business Interest Expense in a tax year, such amount is allocated among the partners and treated as a carryforward at the partner level. Such amounts, referred to as “Excess Business Interest” can only be offset by a future allocation of Excess Taxable Income of that partnership.
• If a partner, after first offsetting all of its partnership carryforward interest expense, has remaining Excess Taxable Income, such Excess Taxable Income can be used to increase the partner’s “standalone” limit.
Partnership ATI x
Business Interest Expense Limitation (ATI x .3) – Net Business Interest Expense
Business Interest Expense Limitation
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Notice 2018-28
Interest Expense Limitation (§163(j))
• Carryforwards of interest under prior 163(j) are allowed for purposes of the new 163(j) provisions.
• Moreover, carryforwards of interest from pre-2018 taxable year will be subject to the BEAT similar to
interest arising in post-2017 taxable years.
• Corporations only have business interest expense and business interest income (interest cannot be
nonbusiness).
• Section 163(j) applies to the consolidated group with forthcoming regulations allocating the deduction
and carryforwards to various members of the group.
• Section 163(j) will not affect the calculation of E&P of a C corporation.
11
Section 163(j)
State and Local Considerations
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Fixed date conformity states would follow the rules of former Section 163(j)
State corporate tax code conf. to IRC – as of April 13, 2018
Disclaimer: Slide to be used for illustrative purposes only. Not to be used as a substitute for research into application of rules.
State conformity to IRC references specific (and/or decouples from specific) Tax Reform provisions
ID - 12/21/17 (2017 TY) or 12/31/17 (2018 TY)
VA – 2017 tax year conformity only
GA – 2/9/2018. Selective nonconformity
FL – 1/1/2018. Nonconformity to 100% bonus
WI – 12/31/2017. Selective nonconformity
AZ – 2017 tax year conformity only
OR – Selective nonconformity
*Contact a tax advisor for more information*
Selective Conformity
AL - Current
AR - Varies by
IRC section
CA - 1/1/15
MS - Current
Specific Date Conformity
AZ - 1/1/17
FL - 1/1/18
GA – 2/9/18
HI - 12/31/16
ID – 12/21/17 or
12/31/17
IN - 1/1/16
IA - 1/1/15
KY - 12/31/17
ME - 12/31/16
MI* - Current or
1/1/18
MN - 12/16/16
NH - 12/31/16
NC - 1/1/17
SC - 12/31/16
TX - 1/1/07
VA – 2/9/2018
VT - 12/31/16
WI – 12/31/17
WV - 12/31/17
Rolling conformity to IRC currently in effect
Selectively conforms (as noted for each affected state to ‘IRC currently in effect’, or
to ‘IRC as of a specific date.’)
Conforms to IRC as of a specific date (as noted for each affected state)
Not applicable b/c state does not levy an
entity level tax with an IRC reference point
FL
NM
DE
MD
TX
OK
KS
NE
SD
NDMT
WY
COUT
ID
AZ
NV
WA
CA
OR
KY
ME
NY
PA
MI*
VT
NH
MA
RICT
VAWV
OHINIL
NCTN
SC
ALMS
AR
LA
MO
IA
MN
WI
NJ
GA
DC
AK
HI
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Multistate ConsiderationsLimitation Calculation
• Issues to be Resolved by States
1. Should the limitation be applied at separate company level or combined group level (i.e., who is the “taxpayer”?)
2. What happens when combined group is different than consolidated group?
3. Is disallowed interest a tax asset of the group or a particular entity? How is it to be allocated among group members (e.g., if an entity leaves a group)?
4. It is currently unclear whether GILTI inclusions would increase the Section 163(j) limitation – state impact if a DRD or other exclusion is available for GILTI income?
5. What if the interest expense is treated as a non-business expense for state tax purposes?
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Multistate ConsiderationsIntercompany Interest Addback Rules
• State interest addback rules would generally apply after determination of deductible interest amount pursuant to Section 163(j)
• Issues to be Resolved by States
1. If the entity has both intercompany and third-party interest expense, what portion of the post-limitation deduction is subject to addback?
2. Many states offer exceptions to the addback requirements for “interest paid during the tax year” to a specified recipient (e.g., treaty country resident). If interest is deducted in a different year than the interest was paid – would the exception still apply?
• Example of Allocation between different sources of interest expense and considerations:
• Third party interest expense $100,000• Related party interest expense $100,000• Total $200,000
• Federal 163(j) limit (assumed) $150,000• Carry forward: $50,000
• How much of the $150,000 current deduction is related party?
• Need to determine what the state add-back applied to (Total $200,000 or Allowed $150,000)
• Need to determine how the safe harbors apply:
◦ If the safe harbors apply to the amount currently deducted, there may be significant timing issues for provisions such as the conduit exceptions.
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Interaction of Section 163(j) and State Intercompany Addback Rules
Is interest limited under
Section 163(j)?
• Section 163(j) limitation calculation
• Proper calculation level
YES NO
Is any deductible interest
paid to a related party in
a state with an addback
requirement?YES
Does an full addback
exception apply?
Deduct Federal
Interest
• Amount of post limitation deduction that is intercompany vs 3rd party
NO
YES• If applicable, was the interest “paid in the taxable year”?
Deduct Partially Allowed
Interest or No Interest
NO
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Section 163(j) Calculation Example
State A State B State C State D
Combined/Consolidated/Separate
Combined Combined Consolidated Separate
(Sub only)
Conformity to 2018 IRC No Yes Yes Yes
Section 163(j) applies? Only to $30M I/C interest
Yes Yes Yes
Limitation at group or separate entity level
Group Separate Group Separate
Section 163(j) limitation 50% x $2B = $1B 30% x ($1B) = ($300M) –cannot be less than zero
30% x $2B = $600M N/A
Disallowed Deduction $0 $100M $0 N/A
Assumptions
• No business interest income
• Consolidated groups will calculate limitation on a consolidated basis
• Prior debt/equity safe harbor does not apply
Facts• Two entities in group – Parent and Subsidiary• Interest Paid Parent = $100M - $70M to Bank, $30M
to Lux Affiliate | Subsidiary = $0• ATI Parent = ($1B) | Subsidiary $3B
17
Effects of Tax Reform on Debt IssuancePotential for a Sea Change?
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Effects of Tax Reform on Debt Issuance
• Post Tax Reform, there will be less incentive to have “repatriation notes” where interest and principal paid
by foreign subsidiaries was seen as an effective way to repatriate cash to the US without a dividend
o Transition tax will create large amounts of federal previously taxed income (“PTI”)
o GILTI inclusion effectively ends most offshore deferral
o Section 245A would potentially provide a 100% DRD for certain repatriated cash
• If companies begin to repatriate more via dividend, potential beneficial effect on the state tax rate due to
availability of foreign DRDs
• Section 163(j) limitation may cause companies to re-evaluate their debt profile, including the level of debt
borne by each member of the group
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Additional analysis necessary for state purposes
• State specific calculation at each separate legal entity
o Conformity
o Separate entity vs consolidated or combined group
o State adjusted taxable income (ATI)
o State modifications (including bonus depreciation/100% expensing, etc)
o ATI excludes depreciation, amortization, or depletion deductions only for tax years beginning before January 1, 2022.
• Consider interplay with other "pre-tax reform" state modifications affecting interest, such as related party addbacks and interest disallowance attributable to foreign dividends
• Analysis to align interest expense and income
o Consider structural changes
20
Questions
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Contact information
Conrad Krol
Deloitte Tax LLP
Alexis Morrison-Howe
Deloitte Tax LLP
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This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.
Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.
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