Bulletin No. 2020–40

HIGHLIGHTS

OF THIS ISSUE





Bulletin No. 2020–40

September 28, 2020

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

ADMINISTRATIVE

INCOME TAX

Notice 2020-66, page 785.

Notice 2020-59, page 782.

This notice provides interim guidance addressing whether

certain Medicaid coverage of COVID-19 testing and diagnostic services is minimum essential coverage for purposes of

the premium tax credit under section 36B of the Internal Revenue Code. This notice also announces that the Department

of the Treasury and the Internal Revenue Service intend to

amend § 1.5000A-2 of the Income Tax Regulations to add

Medicaid coverage of COVID-19 testing and diagnostic services to the list of health care coverage that is not minimum

essential coverage under a government-sponsored program.

ADMINISTRATIVE, EMPLOYEE PLANS

Announcement 2020-17, page 794.

Announcement 2020-17 postpones, until January 15, 2021,

the due dates for reporting and paying the excise taxes under §§ 4971(a)(1) and 4971(f)(1) of the Internal Revenue

Code with respect to certain delayed minimum required contributions to a single employer defined benefit plan. This

postponement applies with respect to a required contribution

to which the extended due date under § 3608(a) of the Coronavirus Aid, Relief, and Economic Security Act, Pub. L. No.

116-136 (134 Stat. 281) (CARES Act), applies.

EMPLOYEE PLANS

Notice 2020-72, page 789.

This notice sets forth updates on the corporate bond monthly yield curve, the corresponding spot segment rates for

September 2020 used under § 417(e)(3)(D), the 24-month

average segment rates applicable for September 2020, and

the 30-year Treasury rates, as reflected by the application of

§ 430(h)(2)(C)(iv).

Finding Lists begin on page ii.

This notice contains a proposed revenue procedure with a

safe harbor for a trade or business that manages or operates a qualified residential living facility to be treated as a real

property trade or business solely for purposes of qualifying

as an electing real property trade or business under section

163(j)(7)(B) of the Internal Revenue Code.

Notice 2020-71, page 786.

Optional special per diem rates. This notice provides the

2020-2021 special per diem rates for taxpayers to use in

substantiating the amount of ordinary and necessary business expenses incurred while traveling away from home.

The notice includes (1) the special transportation industry

rate, (2) the rate for the incidental expenses only deduction,

and (3) the rates and list of high-cost localities for the highlow substantiation method.

REG-107911-18, page 795.

This notice of proposed rulemaking supplements TD 9905

and provides rules concerning the limitation on the deduction

for business interest expense. Specifically, these proposed

regulations address application of the limitation in contexts

involving passthrough entities, regulated investment companies (RICs), United States shareholders of controlled foreign

corporations, and foreign persons with effectively connected

income in the United States. These proposed regulations also

provide guidance regarding the definitions of real property development, real property redevelopment, and a syndicate.

Rev. Proc. 2020-41, page 793.

Revenue Procedure 2020-41 provides domestic asset/liability percentages and domestic investment yields needed by

foreign life insurance companies and foreign property and

liability insurance companies to compute their minimum ef-

fectively connected net investment income under section

842(b) of the Internal Revenue Code for taxable years beginning after December 31, 2018.

Rev. Rul. 2020-19, page 611.

This revenue ruling provides guidance on what constitutes a

change in basis of computing life insurance reserves under

§ 807(f) of the Internal Revenue Code, as amended by the

Tax Cuts and Jobs Act. This revenue ruling provides specific

holdings in a number of different situations, with each holding indicating whether the described situation is a change in

basis under § 807(f).

T.D. 9905, page 614.

This document contains final regulations providing

guidance about the limitation on the deduction for

business interest expense. The regulations provide

guidance to taxpayers on how to calculate the limitation, what constitutes interest for purposes of the limitation, which taxpayers and trades or businesses are

subject to the limitation, and how the limitation applies

in consolidated group, partnership, international, and

other contexts.

The IRS Mission

Provide America’s taxpayers top-quality service by helping

them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

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Revenue rulings represent the conclusions of the Service

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identifying details and information of a confidential nature are

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Rulings and procedures reported in the Bulletin do not have the

force and effect of Treasury Department Regulations, but they

may be used as precedents. Unpublished rulings will not be

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the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

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The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

September 28, 2020 

Bulletin No. 2020–40

Part I

Section 807.—Rules for

certain reserves

Rev. Rul. 2020-19

ISSUE

In the situations described below, is

there a change in basis of computing life

insurance reserves under § 807(f) of the

Internal Revenue Code, as amended by

section 13513 of Public Law No. 115-97,

commonly referred to as the Tax Cuts and

Jobs Act (TCJA), 131 Stat. 2054, 2143

(2017)?

FACTS

IC, a calendar year life insurance company within the meaning of § 816(a), issues life insurance and annuity contracts

directly and also reinsures the risks on

such contracts issued by other companies. IC is required to determine life insurance reserves under § 807(d) with

respect to both directly written and reinsured contracts and to take net increases

or decreases in the reserves into account

in computing life insurance company taxable income. IC computes the amount of

the life insurance reserve for a contract in

accordance with the net surrender value

(NSV) floor of § 807(d)(1)(A) and (B) and

the statutory cap of § 807(d)(1)(C).

Situation 1. Beginning in Year 1, IC

issues variable annuity contracts within

the meaning of § 817(d). On its Federal

income tax returns for Years 1 and 2, IC

computed the amount of the reserve with

regard to each of those contracts under the

Commissioners’ Annuities Reserve Valuation Method (CARVM) prescribed by the

National Association of Insurance Commissioners (NAIC) but incorrectly applied

the 92.81% factor of § 807(d)(1)(B) to

that entire amount, rather than only to the

excess of that amount over the greater of

each contract’s NSV or the portion of the

reserve separately accounted for under

§ 817.

Situation 2. In Year 4, the NAIC makes

a change to the NAIC Valuation Manual

21 (VM-21) that imposes a new compu-

Bulletin No. 2020–40

tational requirement as a component of

CARVM on issuers of variable annuities

with guaranteed minimum benefits. The

requirement applies to the determination

of statutory reserves as of December 31,

Year 4, with regard to contracts issued after December 31, Year 1. On its Federal

income tax returns for Years 2 and 3, IC

determined its reserves for variable annuity contracts under the requirements of

VM-21. As a result of the change in VM21, IC’s statutory reserves for these contracts as of December 31, Year 4, will be

lower than they would have been had the

change not been made.

Situation 3. The facts are the same as

in Situation 2, except that the change to

VM‑21 applies to the determination of

statutory reserves as of December 31,

Year 4, with regard to contracts issued after December 31, Year 3.

Situation 4. The NAIC issues a new

Actuarial Guideline that imposes a new

computational requirement for the Commissioners’ Reserve Valuation Method

(CRVM) for universal life contracts issued

before Year 1. The requirement applies to

the determination of statutory reserves for

these contracts as of December 31, Year 3.

IC’s statutory reserves for these contracts

as of December 31, Year 3, will be lower

than they would have been had the NAIC

not issued the new Actuarial Guideline.

Situation 5. IC computes its reserves

for a group of life insurance contracts under NAIC Valuation Manual 20 (VM-20).

The group of contracts passes both the

stochastic exclusion test and the deterministic exclusion test of VM-20, and the

company elects to exclude the group from

both the stochastic reserve calculation

and the deterministic reserve calculation.

Accordingly, the statutory reserve for the

group is equal to the sum of the policy net

premium reserves.

VM-20 prescribes the mortality standard

to be used to compute the net premium reserves for the contracts. The NAIC changes

the Valuation Manual to require the use of

the Year 1 Commissioners’ Standard Ordinary (CSO) mortality tables to compute

the net premium reserves for all contracts

subject to VM-20. The requirement applies

to the determination of statutory reserves

for these contracts as of December 31,

611

Year 3. IC’s statutory reserves for each of

the contracts in the group of contracts as of

December 31, Year 3, will be lower than

they would have been had the NAIC not

changed the Valuation Manual to prescribe

the use of the Year 1 CSO mortality tables.

Situation 6. IC computes its reserves

for certain life insurance contracts under

VM‑20. Under VM-20, the minimum statutory reserve for the contracts is equal to

the sum of the policy minimum net premium reserves for the contracts, plus the

excess, if any, of the greater of the deterministic reserve for the contracts and the

stochastic reserve for the contracts. For the

taxable years ended December 31, Year 1,

and December 31, Year 2, the deterministic reserve exceeded both the stochastic

reserve and the sum of the policy net premium reserves for the contracts and thus

was the statutory reserve reported on the

NAIC annual statement. The excess of the

deterministic reserve over the sum of the

policy net premium reserves was allocated

to individual contracts in the manner prescribed by VM-20. IC’s statutory reserves

at December 31, Year 3, were equal to the

sum of the policy net premium reserves

for the contracts because this amount exceeded the deterministic reserve and stochastic reserve as of that date. There was

no change in the method of computing

the deterministic reserve, the stochastic

reserve, or the sum of the policy net premium reserves for the contracts in Year 3.

Situation 7. IC computes its reserves

for certain life insurance contracts under

VM‑20. Under VM-20, the minimum statutory reserve for the contracts is equal to

the sum of the policy minimum net premium reserves for the contracts, plus the

excess, if any, of the greater of the deterministic reserve for the contracts and the

stochastic reserve for the contracts. For the

taxable years ended December 31, Year 1,

and December 31, Year 2, the deterministic reserve exceeded both the stochastic

reserve and the sum of the policy net premium reserves for the contracts, and thus

was the statutory reserve reported on the

NAIC annual statement. Pursuant to the

requirements of VM-20, this excess was

allocated to individual contracts. For purposes of computing the deterministic reserve, section 9.c.2 of VM-20 requires that

September 28, 2020

company experience mortality rates be determined for each mortality segment and

that the company experience data used to

determine those rates be updated at least

every three years. Because of the VM-20

mandated update, the mortality rates used

for certain segments to compute the deterministic reserve as of December 31, Year

2, differed from those used for purposes of

computing the deterministic reserve as of

December 31, Year 1.

Situation 8. On its Federal income tax

return for the taxable year ended December 31, Year 1, IC reported tax reserves

for certain fixed annuity contracts equal

to 92.81% of the CARVM reserves for

the contracts, because that amount for

each contract exceeded the NSV for each

contract. For the taxable year ended December 31, Year 2, IC instead reported tax

reserves equal to the NSV of those same

contracts because that amount for each

contract was greater than 92.81% of the

CARVM reserve for each contract. There

was no change in the CARVM or in the

method of computing the NSV for any

contract in Year 2.

Situation 9. For purposes of computing

its life insurance reserves under § 807(d),

IC organizes its life insurance contracts

into policy groupings or cells, each consisting of policies that are identical as to

plan of insurance, year of issue or contract

duration, age of issue, and other factors.

In Year 2, after filing its Federal income

tax return for the Year 1 taxable year, IC

discovered that due to a computer programming error the policy cells for certain contracts issued during Year 1 had

been omitted from the computation of

IC’s closing Year 1 tax reserves. Had the

omitted policy cells been included in IC’s

closing Year 1 reserves, IC’s life insurance

reserves under § 807(d) at December 31,

Year 1, would have been greater than the

amounts originally claimed. The computer programming error took place in Year 1

and affected no other taxable year.

Situation 10. In Year 2, IC announced

to certain of its policyholders that their

policies would, at no increase in premium,

henceforth carry an additional indemnity

benefit should death result from a non-occupational vehicular accident. At the end

of Year 2, IC included in its reserves for the

relevant contracts an additional amount

for the present value of this additional fu-

September 28, 2020

ture unaccrued obligation. The additional

amount would be a life insurance reserve

under § 816(b) and was determined under

a tax reserve method within the meaning

of § 807(d)(2).

LAW AND ANALYSIS

Section 811(a) provides that a life insurance company is required to compute

its taxable income using an accrual method of accounting or, to the extent permitted under regulations prescribed by the

Secretary of the Treasury or his delegate

(Secretary), using a combination of an accrual method of accounting with another

permissible method (other than the cash

receipts and disbursements method). To

the extent not inconsistent with the requirement in the preceding sentence or

other Federal income tax rules applicable to life insurance companies, all such

computations, however, are to be made

in a manner consistent with the manner

required for purposes of the annual statement approved by the NAIC.

Section 803(a)(2) requires income to

be taken into account for any net decrease

in reserves described in § 807(c). Similarly, § 805(a)(2) authorizes a deduction for

any net increase in reserves described in

§ 807(c). Under § 807(c)(1), the reserves

to which this treatment applies include

“life insurance reserves (as defined in

§ 816(b)).”

Section 807(d)(1) provides rules for

determining the amount of life insurance

reserves other than for purposes of § 816

(relating to qualification as a life insurance company). In general, the amount of

the life insurance reserve with respect to

any contract is the greater of the NSV of

the contract or 92.81% of the reserve determined under § 807(d)(2). For a variable

contract, the reserve is the sum of (1) the

greater of the NSV of the contract and the

portion of the reserve separately accounted for under § 817 plus (2) 92.81% of the

excess of the total reserve determined under § 807(d)(2) over the NSV or § 817 reserve, as applicable.

Section 807(d)(2) provides that the reserve for any contract must be determined

using the tax reserve method applicable to

the contract. Section 807(d)(3) provides

that the applicable tax reserve method is

(1) in the case of a contract covered by

612

the CRVM, the CRVM prescribed by the

NAIC that is applicable to the contract and

in effect as of the date the reserve is determined and (2) in the case of a contract

covered by the CARVM, the CARVM

prescribed by the NAIC that is applicable

to the contract and in effect as of the date

the reserve is determined.

Section 807(f) provides that if the basis for determining any item referred to

in § 807(c), which includes life insurance

reserves, as of the close of any taxable

year differs from the basis for determining

that item as of the close of the preceding

taxable year, then so much of the difference between (1) the amount of the item

at the close of the taxable year, computed

on the new basis, and (2) the amount of

the item at the close of the taxable year,

computed on the old basis, as is attributable to contracts issued before the taxable

year, is taken into account under § 481(a)

as an adjustment attributable to a change

in method of accounting initiated by the

taxpayer and made with the consent of the

Secretary.

Section 1.807-4(a) of the Income Tax

Regulations provides that a change in

basis of computing an item referred to in

§ 807(c) is a change in method of accounting for purposes of § 1.446-1(e), unless

§ 1.446-1(e) provides otherwise. Accordingly, a change in basis under § 807(f) is

a change in method of accounting subject

to § 446(e) and the regulations thereunder.

In accordance with § 446(e) and § 1.4461(e), before computing an item described

in § 807(c) under a new basis, a life insurance company must obtain the consent of

the Commissioner of the Internal Revenue

or his delegate (Commissioner) pursuant

to administrative procedures prescribed

by the Commissioner. See section 26.04

of Rev. Proc. 2019-43, 2019-48 I.R.B.

1107 (or successor) (generally providing

the Commissioner’s automatic consent

for a life insurance company to change

its basis of computing an item referred to

in § 807(c)). Section 1.807-4(b) provides

rules relating to the required adjustments

under § 481(a). Section 1.807-4(c) describes how opening and closing balances

of § 807(c) items are determined under

§ 807(a) and (b) when there is a change in

basis under § 807(f).

As with the general rules for methods

of accounting, a company adopts a basis of

Bulletin No. 2020–40

computing an item referred to in § 807(c)

when it uses a permissible basis of computing the item on the first Federal income

tax return that reflects the item. If a company uses an impermissible basis of computing an item on the tax return for one

taxable year, such computation does not

constitute the adoption of a basis of computing the item. However, the consistent

use of an impermissible basis of computing an item on two or more consecutively

filed tax returns establishes the basis of

computing the item. If a company has adopted a basis of computing an item, it may

not change the basis by amending its prior

tax returns. See Rev. Rul. 90-38, 1990-1

C.B. 57; Rev. Rul. 2003-127, 2003-2 C.B.

1245; Thrasys, Inc. v. Commissioner, T.C.

Memo 2018-199. Additionally, a change

in an item referred to in § 807(c) resulting

from a change in underlying facts or from

the correction of mathematical or posting

errors is not a change in basis of computing the item under § 807(f). See § 1.4461(e)(2)(ii)(b).

In Situation 1, IC applied the 92.81%

factor of § 807(d) impermissibly on two

consecutively filed Federal income tax

returns – those for Year 1 and Year 2. IC

therefore adopted an impermissible basis

of computing reserves (old basis). Applying the 92.81% factor to the correct

portion of the reserve determined under

§ 807(d)(2) (new basis) for Year 3 (year

of change) is a change in basis under

§ 807(f). For the year of change, IC must

obtain the consent of the Commissioner to

make this change following the applicable

administrative guidance under § 446(e)

and § 1.446-1(e) and account for the difference between the tax reserve computed

on the new basis as of December 31, Year

3, and the tax reserve computed on the old

basis as of December 31, Year 3, attributable to contracts issued before Year 3, as

an adjustment under § 481(a).

In Situation 2, a change to VM-21 imposes a new computational requirement

as a component of CARVM on issuers

of variable annuities with guaranteed

minimum benefits (new basis). The requirement applies to the determination of

reserves as of December 31, Year 4 (year

of change), and revises the prior VM-21

requirements (old basis) with regard to

contracts issued after December 31, Year

1. Because for Federal income tax purpos-

Bulletin No. 2020–40

es § 807(d)(3)(B)(ii) requires the use of

the CARVM “which is applicable to the

contract and in effect as of the date the reserve is determined,” the change to VM21 is required to be taken into account for

purposes of applying § 807(d). The new

requirement represents a change in the

methodology for satisfying the CARVM

as prescribed by the NAIC. The change is

therefore a change in basis under § 807(f).

IC must obtain the consent of the Commissioner to make this change and must

account for the difference between the tax

reserve computed on the new basis as of

December 31, Year 4, and the tax reserve

computed on the old basis as of December

31, Year 4, attributable to contracts issued

after Year 1 and before Year 4 as an adjustment under § 481(a).

In Situation 3, as in Situation 2, the new

requirement (new basis) is a change in

the methodology for satisfying CARVM

and is therefore a change in basis under

§ 807(f). IC must obtain the consent of the

Commissioner to make this change. Because the change only applies to contracts

issued after Year 3, the change is made on

a cut-off basis and no adjustment is required under § 481(a). See section 2.07 of

Rev. Proc. 2015-13.

In Situation 4, a newly-issued Actuarial Guideline imposes a new computational

requirement for the CRVM for universal

life contracts (new basis). The requirement

applies to the determination of reserves as

of December 31, Year 3 (year of change),

and revises the prior CRVM requirements

(old basis) with regard to contracts issued

before Year 1. Because for Federal income

tax purposes § 807(d)(3)(B)(i) requires

the use of the CRVM “which is applicable to the contract and in effect as of the

date the reserve is determined,” the new

Actuarial Guideline is required to be taken into account for purposes of applying

§ 807(d). The new requirement represents

a change in the methodology for satisfying the CRVM prescribed by the NAIC.

The change is therefore a change in basis

under § 807(f). IC must obtain the consent

of the Commissioner to make this change

and account for the difference between the

tax reserve computed on the new basis as

of December 31, Year 3, and the tax reserve computed on the old basis as of December 31, Year 3, as an adjustment under

§ 481(a).

613

In Situation 5, a group of contracts that

is subject to VM-20 passes both the stochastic and deterministic exclusion tests

of VM-20, and IC elects to exclude the

group from both the stochastic and deterministic reserve calculations. As a result,

the statutory reserve with regard to each

contract is equal to the policy net premium

reserve, and the tax reserve is the greater

of 92.81% of this amount or the contract’s

NSV (old basis). The NAIC changes the

Valuation Manual to require the use of the

Year 1 CSO mortality tables to compute

the net premium reserves for all contracts

subject to VM-20 (new basis), effective

for the determination of statutory reserves

(and, as a result, tax reserves) as of December 31, Year 3 (year of change). IC’s

statutory reserves for each of the contracts

in the group of contracts will be lower

than they would have been had there not

been a change in tables. The new requirement represents a change in the methodology for satisfying the CRVM prescribed

by the NAIC. The change is therefore a

change in basis under § 807(f). IC must

obtain the consent of the Commissioner to

make this change and account for the difference between the tax reserve computed

on the new basis as of December 31, Year

3, and the tax reserve computed on the old

basis as of December 31, Year 3, as an adjustment under § 481(a).

In Situation 6, the comparison of the

sum of the policy net premium reserves

to the stochastic reserve and deterministic

reserve is required under VM-20, which is

the CRVM and the tax reserve method required to be used under § 807(d)(3). As a

result, a change from using the deterministic reserve to using the sum of the policy

net premium reserves is not a change in

basis but rather a function of the yearover-year change in those amounts. The

result would be the same if there had been

a statutory deterministic reserve in Years

1, 2, and 3, and under the terms of VM20 some contracts were not allocated any

deterministic reserve in Years 1 and 2 but

were allocated a portion of the deterministic reserve in Year 3.

In Situation 7, the statutory reserve for

the relevant contracts was equal to the deterministic reserve, and the mortality rates

that IC used for purposes of computing

the deterministic reserve as of December

31, Year 2, differed from those used for

September 28, 2020

purposes of computing the deterministic

reserve as of December 31, Year 1. The

rates were different, however, by reason

of a requirement of VM-20 that the company experience rates be determined for

each mortality segment and that experience data used to determine those rates

be updated at least every three years. The

update in mortality rates, therefore, was

by operation of the reserve methodology

of VM-20, which IC used consistently in

both Year 1 and Year 2. The change therefore is not a change in basis of computing

reserves.

In Situation 8, IC reported tax reserves as of December 31, Year 1, equal

to 92.81% of the CARVM reserve determined under § 807(d)(2) for certain of

its fixed annuity contracts because that

amount for each contract exceeded the

NSV for each of those contracts. It reported tax reserves as of December 31,

Year 2, equal to the NSV of the contracts

because this amount for each contract exceeded 92.81% of the CARVM reserve

determined under § 807(d)(2) for each

contract. Just as in Situation 6, where the

reserve methodology entailed a comparison of the deterministic reserve and the

sum of the policy net premium reserves,

here the reserve methodology entails

a comparison of two amounts, in this

case prescribed by § 807(d) itself. The

fact that year-over-year changes in these

amounts results in different calculated

amounts being taken into account does

not change the principle that the comparison is inherent in the reserve methodology itself, and applying that methodology

consistently is not a change in basis of

computing reserves.

In Situation 9, the understatement

of IC’s reserves at December 31, Year

1, caused by the omission of the policy

cells for certain contracts issued during

Year 1 is the result of a mathematical or

posting error. Correction of IC’s omission

of reserves for certain contracts is not a

change in basis of computing reserves.

See § 1.446-1(e)(2)(ii)(b). Because this

mathematical or posting error occurred

only on its Federal income tax return for

Year 1, IC should file an amended return

for that taxable year, restating the closing

reserves at December 31, Year 1, to reflect

the correct reserve amounts and taking

these recomputed reserves into account in

September 28, 2020

redetermining its life insurance company

taxable income for that year.

In Situation 10, there was no reserve

attributable to the new life insurance benefit at the close of Year 1 because the new

life insurance benefit did not exist before

the company became contractually liable for it in Year 2. The addition of the

new benefit in Year 2 is a change in fact.

An increase in reserve resulting from a

change in fact is not a change in basis of

computing reserves. See § 1.446-1(e)(2)

(ii)(b). Accordingly, the increase in reserves solely to provide for the additional

contractual obligation of IC pursuant to

the additional benefits provided during

Year 2 under existing policies is not attributable to a change in basis of computing reserves.

(9) In Situation 9, an inclusion of policy cells that were previously omitted on a

single return is a mathematical or posting

error that is not a change in basis.

(10) In Situation 10, the increase in reserves to provide solely for new benefits

on existing contracts is not a change in

basis.

HOLDINGS

26 CFR 1.163(j)-1 through -11, etc.

(1) In Situation 1, a change in the consistent, impermissible application of the

92.81% factor prescribed by § 807(d) is a

change in basis.

(2) In Situation 2, an NAIC Valuation

Manual change in the methodology for

computing reserves on previously-issued

contracts is a change in basis.

(3) In Situation 3, an NAIC Valuation

Manual change in the methodology for

computing reserves on contracts issued in

the year of the change is a change in basis.

(4) In Situation 4, a change in Actuarial

Guideline that results in a change in the

methodology for computing reserves is a

change in basis.

(5) In Situation 5, a change in the NAIC-prescribed mortality tables is a change

in basis.

(6) In Situation 6, a change under VM20 from the deterministic reserve to the

sum of the policy net premium reserves

due solely to the fact that the sum of the

policy net premium reserves is greater is

not a change in basis.

(7) In Situation 7, an experience-based

update in mortality rates as required by

VM‑20 to determine the deterministic reserve is not a change in basis.

(8) In Situation 8, a change from tax reserves based on 92.81% of the reserve determined under § 807(d)(2) to tax reserves

based on the contract NSV resulting solely

from a year-over-year change in which is

greater is not a change in basis.

614

DRAFTING INFORMATION

The principal author of this revenue

ruling is Ian Follansbee of the Office of

the Associate Chief Counsel (Financial

Institutions and Products). For further information regarding this revenue ruling

contact Ian Follansbee at 202-317-4453

(not a toll-free number).

T.D. 9905

DEPARTMENT OF THE

TREASURY

Internal Revenue Service

26 CFR Parts 1

Limitation on Deduction for

Business Interest Expense

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations providing guidance about

the limitation on the deduction for business interest expense after amendment of

the Internal Revenue Code (Code) by the

provisions commonly known as the Tax

Cuts and Jobs Act, which was enacted on

December 22, 2017, and the Coronavirus

Aid, Relief, and Economic Security Act,

which was enacted on March 27, 2020.

The regulations provide guidance to taxpayers on how to calculate the limitation,

what constitutes interest for purposes of

the limitation, which taxpayers and trades

or businesses are subject to the limitation,

and how the limitation applies in consolidated group, partnership, international,

and other contexts.

Bulletin No. 2020–40

DATES: Effective date: The regulations

are effective on November 13, 2020. Sections 1.163(j)-1 through 1.163(j)-11 are

generally applicable to taxable years beginning on or after November 13, 2020.

Applicability dates: For dates of applicability, see §§1.163(j)-1(c), 1.163(j)-2(k),

1.163(j)-3(d), 1.163(j)-4(g), 1.163(j)-5(h),

1.163(j)-6(p), 1.163(j)-9(k), 1.163(j)10(f), 1.163(j)-11(d), 1.263A-15(a),

1.381(c)(20)-1(d), 1.382-2(b)(3), 1.3825(f), 1.382-6(h), 1.383-1(j), 1.446-3(j)(2),

1.469-11(a)(3) and (4), 1.1502-36(h)(2),

1.1502-99(d), and 1.1504-4(i).

Pursuant to section 7805(b)(7), taxpayers and their related parties, within the

meaning of sections 267(b) and 707(b)(1),

may apply the rules set forth in §§1.163(j)1 through 1.163(j)-11, in their entirety, to

a taxable year beginning after December

31, 2017, and before November 13, 2020,

so long as the taxpayers and their related

parties consistently apply these rules, and,

if applicable, §§1.263A-9, 1.263A-15,

1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5,

1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.4699, 1,469-11, 1.704-1, 1.882-5, 1.1362-3,

1.1368-1, 1.1377-1, 1.1502-13, 1.150221, 1.1502-36, 1.1502-79, 1.1502-90,

1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.3822, 1.382-5, 1.382-6, and 1.383-1), and

1.1504-4, to that taxable year. However,

see §1.163(j)-1(c) for the applicability

date rules relating to notional principal

contracts and the interest anti-avoidance

rule; see also part II(E)(2) (relating to notional principal contracts) and part II(E)

(4) (relating to the interest anti-avoidance

rule) of the Summary of Comments and

Revisions section of this preamble.

Alternatively, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may rely on

proposed §§1.163(j)-1 through 1.163(j)11, which were issued in a notice of proposed rulemaking (REG-106089-18) and

published on December 28, 2018, in the

Federal Register (83 FR 67490), in their

entirety, for a taxable year beginning after

December 31, 2017, and before November 13, 2020, so long as the taxpayers

and their related parties consistently apply proposed §§1.163(j)-1 through -11,

and, if applicable, proposed §§1.263A-9,

1.381(c)(20)-1, 1.382-1, 1.382-2, 1.3825, 1.382-6, 1.382-7, 1.383-0, 1.383-1,

Bulletin No. 2020–40

1.469-9, 1.469-11, 1.882-5, 1.1502-13,

1.1502-21, 1.1502-36, 1.1502-79, 1.150291 through 1.1502-99 (to the extent they

effectuate the rules of §§1.382-2, 1.3825, 1.382-6, and 1.383-1), and 1.1504-4,

to that taxable year. Notwithstanding the

preceding sentence, taxpayers applying

the provisions in the notice of proposed

rulemaking may apply §1.163(j)-1(b)(1)

(iii) in these final regulations for taxable

years beginning after December 31, 2017.

With respect to §1.382-2 and, if applicable, §§1.1502-91 through 1.1502-99

(to the extent they effectuate the rules of

§1.382-2), and with respect to §1.382-5

and, if applicable, §§1.1502-91 through

1.1502-99 (to the extent they effectuate

the rules of §1.382-5), the regulations apply to testing dates and ownership changes, respectively, occurring on or after November 13, 2020.

Taxpayers and their related parties,

within the meaning of sections 267(b) and

707(b)(1), may choose to apply the rules

of §1.382-2 and, if applicable, §§1.150291 through 1.1502-99 (to the extent they

effectuate the rules of §1.382-2), and

§1.382-5 and, if applicable, §§1.1502-91

through 1.1502-99 (to the extent they effectuate the rules of §1.382-5), to a testing

date or an ownership change, respectively, that occurs in a taxable year beginning

after December 31, 2017, and before November 13, 2020, so long as the taxpayers

and their related parties consistently apply the rules of §§1.163(j)-1 through -11,

1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.3827, 1.383-0, and 1.383-1, and, if applicable, §§1.263A-9, 1.263A-15, 1.381(c)

(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.8825, 1.1362-3, 1.1368-1, 1.1377-1, 1.150213, 1.1502-21, 1.1502-36, 1.1502-79,

1.1502-90, 1.1502-91 through 1.1502-99

(to the extent they effectuate the rules of

§§1.382-2, 1.382-5, 1.382-6, and 1.3831), and 1.1504-4, to that taxable year.

Alternatively, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may rely on

the rules of proposed §1.382-2 and, if

applicable, §§1.1502-91 through 1.150299 (to the extent they effectuate the rules

of §1.382-2), and §1.382-5 and, if applicable, §§1.1502-91 through 1.1502-99

(to the extent they effectuate the rules of

§1.382-5), which were issued in a notice

of proposed rulemaking (REG-106089-

615

18) and published on December 28, 2018,

in the Federal Register (83 FR 67490),

with respect to a testing date or an ownership change, respectively, that occurs in

a taxable year beginning after December

31, 2017, and before November 13, 2020,

so long as the taxpayers and their related

parties consistently apply the rules of proposed §§1.163(j)-1 through -11, 1.382-1,

1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.3830, and 1.383-1, and, if applicable, proposed

§§1.263A-9, 1.381(c)(20)-1, 1.469-9,

1.469-11, 1.882-5, 1.1502-13, 1.1502-21,

1.1502-36, 1.1502-79, 1.1502-90, 1.150291 through 1.1502-99 (to the extent they

effectuate the rules of §§1.382-2, 1.3825, 1.382-6, and 1.383-1), and 1.1504-4,

to that taxable year. As noted previously,

taxpayers relying on the provisions in the

notice of proposed rulemaking may apply

§1.163(j)-1(b)(1)(iii) in these final regulations for taxable years ending after December 31, 2017.

FOR

FURTHER

INFORMATION

CONTACT: Concerning §1.163(j)-1,

§1.163(j)-2, §1.163(j)-3, §1.163(j)-9,

§1.263A-9, or §1.263A-15, Sophia Wang,

(202) 317-4890 or Justin Grill, (202) 3174850; concerning §1.163(j)-4, §1.163(j)5, §1.163(j)-10, §1.163(j)-11, §1.381(c)

(20)-1, §1.382-1, §1.382-2, §1.382-5,

§1.382-6, §1.382-7, §1.383-0, §1.3831, §1.1502-13, §1.1502-21, §1.1502-36,

§1.1502-79, §1.1502-90, §1.1502-91,

§1.1502-95, §1.1502-98, §1.1502-99, or

§1.1504-4, Russell Jones, (202) 317-5357,

John Lovelace, (202) 317-5363, Aglaia

Ovtchinnikova, (202) 317-6975, or Marie C. Milnes-Vasquez, (202) 317-3181;

concerning §1.163(j)-6, §1.469-9(b)(2),

§1.469-11, §1.704-1, §1.1362-3, §1.13681, or §1.1377-1, William Kostak, (202)

317-6852, Anthony McQuillen, (202) 3175027, or Adrienne Mikolashek, (202) 3175050; concerning §1.163(j)-7, §1.163(j)8, or §1.882-5, Azeka Abramoff, (202)

317-3800, Angela Holland, (202) 3175474, or Steve Jensen, (202) 317-6938;

concerning §1.446-3, §1.860C-2, RICs,

REITs, REMICs, and the definition of the

term “interest”, Michael Chin, (202) 3175846 (not toll-free numbers).

ADDRESSES: Submit electronic submissions to the Federal eRulemaking Portal

at http://www.regulations.gov (indicate

September 28, 2020

IRS and REG-106089-18) by following

the online instructions for submitting

comments. Once submitted to the Federal eRulemaking Portal, comments cannot

be edited or withdrawn. The Department

of the Treasury (Treasury Department)

and the Internal Revenue Service (IRS)

will publish for public availability any

comment received to its public docket,

whether submitted electronically or in

hard copy. Send hard copy submissions

to CC:PA:LPD:PR (REG-106089-18),

Room 5203, Internal Revenue Service,

P.O. Box 7604, Ben Franklin Station,

Washington, DC 20044.

SUPPLEMENTARY INFORMATION:

Background

Table of Contents

I. Overview

II. Comments on and Changes to Proposed §1.163(j)-1: Definitions

A. Definition and Calculation of Adjusted Taxable Income (ATI) – Proposed

§1.163(j)-1(b)(1)

1. Taxable Income and Tentative Taxable

Income

2. Adjustments to ATI for Amounts Incurred as Depreciation, Amortization, and

Depletion

3. ATI and Floor Plan Financing Interest

4. Adjustments to Taxable Income in

Computing ATI Under Section 163(j)(8)

(A)

5. Certain Adjustments to Tentative Taxable Income in Computing ATI Under

Section 163(j)(8)(B)

6. Adjustments to Adjusted Taxable Income in Respect of United States Shareholders of CFCs

B. Definition of Business Interest Expense

– Proposed §1.163(j)-1(b)(2)

C. Definition of Excepted Regulated Utility Trade or Business – Proposed §1.163(j)1(b)(13)

D. Definition of Floor Plan Financing Interest Expense – Proposed §1.163(j)-1(b)

(17)

E. Definition of Interest – Proposed

§1.163(j)-1(b)(20)

1. In General

2. Swaps with Significant Nonperiodic

Payments

3. Other Amounts Treated as Interest

September 28, 2020

i. Items Relating to Premium, Ordinary

Income or Loss on Certain Debt Instruments, Section 1258 Gain, and Factoring

Income

ii. Substitute Interest Payments

iii. Commitment Fees

iv. Debt Issuance Costs

v. Guaranteed Payments

vi. Hedging Transactions

vii. Other Items

a. Dividends from Regulated Investment

Company (RIC) Shares

b. MMF Income

c. Negative Interest

d. Leases

4. Anti-Avoidance Rule for Amounts Predominantly Associated with the Time

Value of Money

5. Authority Comments

F. Definition of Motor Vehicle – Proposed

§1.163(j)-1(b)(25)

G. Definition of Taxable Income – Proposed §1.163(j)-1(b)(37)

1. Calculation of Taxable Income

2. Interaction with Section 250

3. When Disallowed Business Interest Expense is “Paid or Accrued”

4. Interaction with Sections 461(l), 465,

and 469 – Proposed §1.163(j)-1(b)(37)

H. Definition of Trade or Business – Proposed §1.163(j)-1(b)(38)

1. In General

2. Multiple Trades or Businesses Within

an Entity

3. Rental Real Estate Activities as a Trade

or Business

4. Separate Entities

I. Applicability Dates

III. Comments on and Changes to Proposed §1.163(j)-2: Deduction for Business Interest Expense Limited

A. Whether the Section 163(j) Limitation

is a Method of Accounting

B. General Gross Receipts Test and Aggregation

C. Small Business Exemption and Single

Employer Aggregation Rules – Proposed

§§1.163(j)-2(d) and 1.52-1(d)(1)(i)

D. Small Business Exemption and Tax

Shelters - Proposed §1.163(j)-2(d)(1)

E. Gross Receipts for Partners in Partnerships and Shareholders of S Corporation

Stock – Proposed §1.163(j)-2(d)(2)(iii)

IV. Comments on and Changes to Section

Proposed §1.163(j)-3: Relationship of

Section 163(j) Limitation to Other Provisions Affecting Interest

616

A. Capitalized Interest

B. Provisions that Characterize Interest

Expense as Something Other Than Business Interest Expense

C. Section 108

D. Sections 461(l), 465, and 469

V. Comments on and Changes to Proposed

§1.163(j)-4: General Rules Applicable to

C Corporations (Including Real Estate Investment Trusts (REITs), RICs, and Members of Consolidated Groups) and Tax-Exempt Corporations

A. Aggregating Affiliated but Non-Consolidated Entities

B. Intercompany Transactions and Intercompany Obligations

C. Repurchase Premium on Obligations

that are Deemed Satisfied and Reissued

D. Intercompany Transfers of Partnership

Interests

1. Overview of Proposed §1.163(j)-4(d)

(4)

2. Intercompany Transfers of Partnership Interests Treated as Dispositions;

Single-Entity Treatment; Application of

§1.1502-13

3. Possible Approach to Intercompany

Partnership Interest Transfers

4. Offsetting Excess Business Interest Expense and Adjusted Taxable Income Within the Consolidated Group

5. Intercompany Nonrecognition Transactions

6. Basis Adjustments Under §1.1502-32

7. Partnership Terminations

E. Application of §1.1502-36 to Excess

Business Interest Expense

F. Calculating ATI for Cooperatives

G. Calculating ATI for a Consolidated

Group

H. Application of Section 163(j) to

Life-Nonlife Groups

I. Application of Section 163(j) to Tax-Exempt Entities

J. Partnership Investment Income and

Corporate Partners

K. Earnings and Profits of a Corporate

Partner

VI. Comments on and Changes to Proposed §1.163(j)-5: General Rules Governing Disallowed Business Interest Expense

Carryforwards for C Corporations

A. Absorption of Disallowed Business Interest Expense Carryforwards Before Use

of NOLs in Life-Nonlife Groups

B. Carryforwards from Separate Return

Limitation Years

Bulletin No. 2020–40

C. Offsetting Business Interest Expense

with Business Interest Income and Floor

Plan Financing Interest Expense at the

Member Level

VII. Comments on and Changes to Section 1.163(j)-6: Application of the Business Interest Expense Deduction Limitations to Partnerships and Subchapter S

Corporations

A. Partnership-Level Calculation and Allocation of Section 163(j) Excess Items

1. Nonseparately Stated Taxable Income

or Loss of the Partnership

2. Requested Clarifications and Modifications

3. Recommended Alternative Methods

4. Publicly Traded Partnerships

5. Pro Rata Exception

B. Basis Adjustments

1. Basis and Capital Account Adjustments

for Excess Business Interest Expense Allocations

2. Basis Adjustments Upon Disposition of

Partnership Interests Pursuant to Section

163(j)(4)(B)(iii)(II)

3. Intercompany Transfer of a Partnership

Interest

C. Debt-Financed Distributions

D. Trading Partnerships

E. Treatment of Excess Business Interest

Expense in Tiered Partnerships

F. Partnership Mergers and Divisions

G. Applicability of Section 382 to S Corporations Regarding Disallowed Business

Interest Expense Carryforwards

H. Separate Application of Section 163(j)

Limitation to Short Taxable Years of S

Corporation

I. Partnership or S Corporation Not Subject to Section 163(j)

J. Trusts

K. Qualified Expenditures

L. CARES Act Partnership Rules

VIII. Comments on and Changes to Proposed §1.163(j)-7: Application of the Section 163(j) Limitation to Foreign Corporations and United States Shareholders

IX. Comments on and Changes to Section 1.163(j)-8: Application of the Section 163(j) Limitation to Foreign Persons

with Effectively Connected Taxable Income.

X. Comments on and Changes to Proposed §1.163(j)-9: Elections for Excepted Trades or Businesses; Safe Harbor for

Certain REITs

A. Protective Elections

Bulletin No. 2020–40

B. One-Time Late Election or Withdrawal

of Election Procedures

C. The Anti-Abuse Rule Under Proposed

§1.163(j)-9(h)

D. Residential Living Facilities and Notice with Proposed Revenue Procedure

E. Safe Harbor for Certain REITs

F. Real Property Trade or Business

XI. Comments on and Changes to Proposed §1.163(j)-10: Allocation of Interest Expense, Interest Income, and Other

Items of Expense and Gross Income to an

Excepted Trade or Business.

A. General Method of Allocation: Asset

Basis

B. Allocation Between Trades or Businesses and Non-Trades or Businesses

C. Consolidated Groups

1. Overview

2. Intercompany Transactions

3. Use of Property Derives from an Intercompany Transaction

4. Purchase of Member Stock from a Nonmember

5. Inclusion of Income from Excepted

Trades or Businesses in Consolidated ATI

6. Engaging in Excepted or Non-Excepted

Trades or Businesses as a “Special Status”

D. Quarterly Asset Testing

E. De Minimis Rules

1. Overview

2. Order in Which the De Minimis Rules

Apply

3. Mandatory Application of De Minimis

Rules

4. De Minimis Threshold for Electric Cooperatives

5. Standardization of 90 Percent De Minimis Tests

6. Overlapping De Minimis Tests

F. Assets Used in More than One Trade or

Business

1. Overview

2. Consistency Requirement

3. Changing a Taxpayer’s Allocation

Methodology

4. Mandatory Use of Relative Output for

Utility Trades or Businesses

G. Exclusions from Basis Calculations

H. Look-Through Rules

1. Ownership Thresholds; Direct and Indirect Ownership Interests

2. Application of Look-Through Rules to

Partnerships

i. In General

ii. Coordination of Look-Through Rule

and Basis Determination Rules

617

iii. Applying the Look-Through Rule and

Determining Share of Partnership Basis

iv. Investment Asset Basis Reduction Rule

v. Coordination of Section 752 Basis Reduction Rule and Investment Asset Basis

Reduction Rule

vi. Allocating Basis in a Partnership Interest Between Excepted and Non-Excepted

Trades or Businesses

3. Additional Limitation on Application of

Look-Through Rules to C Corporations

4. Dispositions of Stock in Non-Consolidated C Corporations

5. Application of Look-through Rules to

Small Businesses

6. Application of the Look-Through Rules

to Foreign Utilities

I. Deemed Asset Sale

J. Carryforwards of Disallowed Disqualified Interest

K. Anti-Abuse Rule

L. Direct Allocation

1. Overview

2. Expansion of the Direct Allocation Rule

3. Basis Reduction Requirement for Qualified Nonrecourse Indebtedness

4. Direct Allocation Rule for Financial

Services Businesses

XII. Comments on Proposed Changes to

§1.382-2: General Rules for Ownership

Change

XIII. Comments on Proposed Changes to

§1.382-6: Allocation of Income and Loss

to Periods Before and After the Change

Date for Purposes of Section 382

XIV. Comments on and Changes to Proposed §1.383-1: Special Limitations on

Certain Capital Losses and Excess Credits

XV. Other Comments about Section 382

A. Application of Section 382(l)(5)

B. Application of Section 382(e)(3)

C. Application of Section 382(h)(6)

XVI. Definition of Real Property Trade or

Business

This document contains amendments

to the Income Tax Regulations (26 CFR

part 1) under section 163(j) of the Code.

The final regulations reflect amendments

to section 163(j) made by Public Law 11597, 131 Stat. 2054 (December 22, 2017),

commonly referred to as the Tax Cuts and

Jobs Act (the TCJA) and the Coronavirus Aid, Relief, and Economic Security

Act, Public Law No. 116-136 (2020) (the

CARES Act). Section 13301(a) of the

TCJA amended section 163(j) by remov-

September 28, 2020

ing prior section 163(j)(1) through (9) and

adding section 163(j)(1) through (10) and

significantly changed the limitation for

deducting interest on certain indebtedness. The provisions of section 163(j) as

amended by section 13301 of the TCJA

are effective for tax years beginning after

December 31, 2017. The CARES Act further amended section 163(j) by redesignating section 163(j)(10), as amended by

the TCJA, as new section 163(j)(11), and

adding a new section 163(j)(10) providing

special rules for applying section 163(j) to

taxable years beginning in 2019 or 2020.

All references to “old section 163(j)” in

this document are references to section

163(j) prior to amendment by the TCJA

and the CARES Act, and all references to

“section 163(j)” are references to section

163(j) as amended by the TCJA and the

CARES Act.

Old section 163(j) generally disallowed a deduction for “disqualified interest” paid or accrued by a corporation in

a taxable year if the payor’s debt-to-equity ratio exceeded 1.5 to 1.0, and if the

payor’s net interest expense exceeded 50

percent of its adjusted taxable income.

Disqualified interest included interest

paid or accrued to (1) related parties

when no Federal income tax was imposed

with respect to such interest; (2) unrelated parties in certain instances in which

a related party guaranteed the debt; or

(3) certain real estate investment trusts

(REIT). Interest amounts disallowed for

any taxable year under old section 163(j)

were treated as interest paid or accrued in

the succeeding taxable year and could be

carried forward indefinitely. In addition,

any excess limitation, the excess of the

taxpayer’s net interest expense over 50

percent of its adjusted taxable income,

could be carried forward three years.

The interest limitation under old section

163(j) was designed to prevent a taxpayer from deducting interest from its U.S.

taxable income without a corresponding

inclusion in U.S. taxable income by the

recipient, or to prevent the stripping of

earnings from the U.S. tax system.

In contrast, section 163(j) now applies

broadly to all business interest expense regardless of whether the related indebtedness is between related parties or incurred

by a corporation, and regardless of the

taxpayer’s debt-to-equity ratio. Section

September 28, 2020

163(j) provides an entirely new limitation

on the deduction for “business interest

expense” of all taxpayers, including, for

example, individuals, corporations, partnerships, S corporations, unless a specific exclusion applies under section 163(j).

Although certain terms are used in both

old section 163(j) and section 163(j), such

as “adjusted taxable income,” such terms

have been updated in the final regulations

to reflect the new limitation under section

163(j).

Section 163(j) generally limits the

amount of business interest expense that

can be deducted in the current taxable

year (also referred to in this preamble as

the current year). Under section 163(j)

(1), the amount allowed as a deduction

for business interest expense is limited

to the sum of (1) the taxpayer’s business

interest income for the taxable year; (2)

30 percent of the taxpayer’s adjusted taxable income (ATI) for the taxable year

(30 percent ATI limitation); and (3) the

taxpayer’s floor plan financing interest

expense for the taxable year. As further

described later in this Background section, section 163(j)(10), as amended by

the CARES Act, provides special rules

relating to the 30 percent ATI limitation

for taxable years beginning in 2019 or

2020. The section 163(j) limitation applies to all taxpayers, except for certain

small businesses that meet the gross receipts test in section 448(c) and certain

trades or businesses listed in section

163(j)(7).

Section 163(j)(2) provides that the

amount of any business interest not allowed as a deduction for any taxable year

as a result of the section 163(j) limitation

is carried forward and treated as business

interest paid or accrued in the next taxable year. In contrast to old section 163(j),

section 163(j) does not allow the carryforward of any excess limitation.

Section 163(j)(3) provides that the

section 163(j) limitation does not apply

to a taxpayer, other than a tax shelter as

described in section 448(a)(3), with average annual gross receipts of $25 million

or less, determined under section 448(c)

(including any adjustment for inflation under section 448(c)(4)). For taxpayers other

than corporations or partnerships, section

163(j)(3) provides that the gross receipts

test is determined for purposes of section

618

163(j) as if the taxpayer were a corporation or partnership.

Section 163(j)(4) provides special

rules for applying section 163(j) in the

case of partnerships and S corporations.

Section 163(j)(4)(A) requires that the

limitation on the deduction for business

interest expense be applied at the partnership level, and that a partner’s ATI be

increased by the partner’s share of the

partnership’s excess taxable income, as

defined in section 163(j)(4)(C), but not

by the partner’s distributive share of the

partnership’s income, gain, deduction,

or loss. Section 163(j)(4)(B)(i) provides

that the amount of partnership business

interest expense limited by section 163(j)

(1) is carried forward at the partner level.

Section 163(j)(4)(B)(ii) provides that excess business interest expense allocated

to a partner and carried forward is available to be deducted in a subsequent year

only if, and to the extent, the partnership

allocates excess taxable income to the

partner. As further described later in this

Background section, section 163(j)(10)

(A)(ii)(II), as amended by the CARES

Act, provides a special rule for excess

business interest expense allocated to

a partner in a taxable year beginning in

2019. Section 163(j)(4)(B)(iii) provides

basis adjustment rules for a partner that

is allocated excess business interest expense. Section 163(j)(4)(D) provides that

rules similar to the rules of section 163(j)

(4)(A) and (C) apply to S corporations

and S corporation shareholders.

Section 163(j)(5) and (6) defines “business interest” and “business interest income,” respectively, for purposes of section 163(j). Generally, these terms include

interest expense and interest includible in

gross income that is properly allocable to

a trade or business (as defined in section

163(j)(7)) and do not include investment

income or investment expense within the

meaning of section 163(d). The legislative history states that “a corporation has

neither investment interest nor investment

income within the meaning of section

163(d). Thus, interest income and interest

expense of a corporation is properly allocable to a trade or business, unless such

trade or business is otherwise explicitly

excluded from the application of the provision.” H. Rept. 115-466, at 386, fn. 688

(2017).

Bulletin No. 2020–40

Under section 163(j)(7), the limitation

on the deduction for business interest expense in section 163(j)(1) does not apply

to certain trades or businesses (excepted

trades or businesses). The excepted trades

or businesses are the trade or business of

providing services as an employee, electing real property businesses, electing

farming businesses, and certain regulated

utility businesses.

Section 163(j)(8) defines ATI as the

taxable income of the taxpayer without

regard to the following: items not properly allocable to a trade or business;

business interest and business interest

income; net operating loss (NOL) deductions; and deductions for qualified business income under section 199A. ATI

also generally excludes deductions for

depreciation, amortization, and depletion

with respect to taxable years beginning

before January 1, 2022, and it includes

other adjustments provided by the Secretary of the Treasury.

Section 163(j)(9) defines “floor plan

financing interest” as interest paid or accrued on “floor plan financing indebtedness.” These provisions allow taxpayers

incurring interest expense for the purpose

of securing an inventory of motor vehicles

held for sale or lease to deduct the full expense without regard to the section 163(j)

limitation.

Under section 163(j)(10)(A)(i), the

amount of business interest that is deductible under section 163(j)(1) for taxable years beginning in 2019 or 2020 is

computed using 50 percent, rather than

30 percent, of the taxpayer’s ATI for the

taxable year (50 percent ATI limitation).

A taxpayer may elect not to apply the 50

percent ATI limitation to any taxable year

beginning in 2019 or 2020, and instead

apply the 30 percent ATI limitation. The

election must be made separately for each

taxable year. Once the taxpayer makes the

election, the election may not be revoked

without the consent of the Secretary of

the Treasury or his delegate. See section

163(j)(10)(A)(iii).

Sections 163(j)(10)(A)(ii)(I) and 163(j)

(10)(A)(iii) provide that, in the case of a

partnership, the 50 percent ATI limitation

does not apply to partnerships for taxable

years beginning in 2019, and the election

to not apply the 50 percent ATI limitation

may be made only for taxable years begin-

Bulletin No. 2020–40

ning in 2020. This election may be made

only by the partnership and may not be

revoked without the consent of the Secretary of the Treasury or his delegate. Under

section 163(j)(10)(A)(ii)(II), however, a

partner treats 50 percent of its allocable

share of a partnership’s excess business

interest expense for 2019 as a business interest expense in the partner’s first taxable

year beginning in 2020 that is not subject

to the section 163(j) limitation (50 percent

EBIE rule). The remaining 50 percent of

the partner’s allocable share of the partnership’s excess business interest expense

remains subject to the section 163(j) limitation applicable to excess business interest expense carried forward at the partner

level. A partner may elect out of the 50

percent EBIE rule.

Section 163(j)(10)(B)(i) allows a taxpayer to elect to use its ATI for the last

taxable year beginning in 2019 for the taxpayer’s ATI in determining the taxpayer’s

section 163(j) limitation for any taxable

year beginning in 2020.

Section 163(j)(11) provides cross-references to provisions requiring that electing farming businesses and electing real

property businesses excepted from the

section 163(j) limitation use the alternative depreciation system (ADS), rather

than the general depreciation system for

certain types of property. The required

use of ADS results in the inability of these

electing trades or businesses to use the additional first-year depreciation deduction

under section 168(k) for those types of

property.

On December 28, 2018, the Treasury

Department and the IRS (1) published

proposed regulations under section 163(j)

in a notice of proposed rulemaking (REG106089-18) (proposed regulations) in the

Federal Register (83 FR 67490), and (2)

withdrew the notice of proposed rulemaking (1991-2 C.B. 1040) published in the

Federal Register on June 18, 1991 (56

FR 27907) (as corrected by 56 FR 40285

(August 14, 1991)) to implement rules

under old section 163(j) (1991 Proposed

Regulations). The proposed regulations

were issued following guidance announcing and describing regulations intended to

be issued under section 163(j). See Notice

2018-28, 2018-16 I.R.B. 492.

A public hearing was held on February 27, 2019. The Treasury Department

619

and the IRS received written comments

responding to the notice of proposed

rulemaking. Comments received before

the final regulations were substantially

developed, including all comments received on or before the deadline for comments on February 26, 2019, were carefully considered in developing the final

regulations.

Copies of the comments received are

available for public inspection at http://

www.regulations.gov or upon request.

After consideration of the comments received and the testimony at the public

hearing, this Treasury decision adopts

the proposed regulations as revised in response to such comments and testimony

as described in the Summary of Comments and Explanation of Revisions section. The revisions are discussed in this

preamble. Concurrently with the publication of the final regulations, the Treasury

Department and the IRS are publishing

in the Proposed Rule section of this edition of the Federal Register (RIN 1545BO76) a notice of proposed rulemaking

providing additional proposed regulations under section 163(j) (REG-10791118) (Concurrent NPRM). The Concurrent

NPRM includes proposed regulations relating to changes made to section 163(j)

under the CARES Act.

On September 10, 2019, the Treasury

Department and the IRS published proposed regulations under section 382(h)

(REG-125710-18) in the Federal Register (84 FR 47455) (the September 2019

section 382 proposed regulations). The

September 2019 section 382 proposed

regulations included a rule to clarify that

section 382 disallowed business interest

carryforwards are not treated as recognized built-in losses (RBILs). No formal

comments were received on this rule

during the comment period for the September 2019 section 382 proposed regulations.

On April 10, 2020, the Treasury Department and the IRS released Revenue

Procedure 2020-22, 2020-18 I.R.B. 745,

to provide the time and manner of making

a late election, or withdrawing an election under section 163(j)(7)(B) to be an

electing real property trade or business, or

under section 163(j)(7)(C) to be an electing farming business, for taxable years

beginning in 2018, 2019, or 2020. Reve-

September 28, 2020

nue Procedure 2020-22 also provides the

time and manner of making or revoking

elections provided by the CARES Act

under section 163(j)(10) for taxable years

beginning in 2019 or 2020. As described

earlier in this Background section, these

elections are: (1) to not apply the 50 percent ATI limitation under section 163(j)

(10)(A)(iii); (2) to use the taxpayer’s ATI

for the last taxable year beginning in 2019

to calculate the taxpayer’s section 163(j)

limitation in 2020 under section 163(j)

(10)(B); and (3) for a partner to elect out

of the 50 percent EBIE rule under section

163(j)(10)(A)(ii)(II).

Summary of Comments and

Explanation of Revisions

I. Overview

The Treasury Department and the

IRS received approximately 120 written

comments in response to the notice of

proposed rulemaking. Most of the comments addressing the proposed regulations are summarized in this Summary

of Comments and Explanation of Revisions section. However, comments merely

summarizing or interpreting the proposed

regulations or recommending statutory revisions generally are not discussed in this

preamble. Additionally, comments outside

the scope of this rulemaking are generally

not addressed in this Summary of Comments and Explanation of Revisions section.

The Treasury Department and the IRS

continue to study comments on certain

issues related to section 163(j), including

issues that are beyond the scope of the final regulations (or the Concurrent NPRM

in the Proposed Rules section of this issue

of the Federal Register), and may discuss

those comments if future guidance on

those issues is published.

The final regulations retain the same

basic structure as the proposed regulations, with certain revisions.

II. Comments on and Changes to

Proposed §1.163(j)-1: Definitions

Section 1.163(j)-1 provides definitions

of the terms used in the final regulations.

The following discussion addresses comments relating to proposed §1.163(j)-1.

September 28, 2020

A. Definition and Calculation of Adjusted

Taxable Income (ATI) – Proposed

§1.163(j)-1(b)(1)

2. Adjustments to ATI for Amounts

Incurred as Depreciation, Amortization,

and Depletion

1. Taxable Income and Tentative Taxable

Income

Section 163(j)(8)(A)(v) defines ATI as

the taxable income of the taxpayer computed without regard to certain items,

including any deduction allowable for depreciation, amortization, or depletion for

taxable years beginning before January

1, 2022. Consistent with section 163(j)

(8)(A)(v), proposed §1.163(j)-1(b)(1)(i)

requires an addback to taxable income of

deductions for depreciation, amortization,

and depletion for taxable years beginning

before January 1, 2022. In general, section

263A requires certain taxpayers that manufacture or produce inventory to capitalize

all direct costs and certain indirect costs

into the basis of the property produced or

acquired for resale. Depreciation, amortization or depletion that is capitalized

into inventory under section 263A is recovered through cost of goods sold as an

offset to gross receipts in computing gross

income; cost of goods sold reduces the

amount realized upon the sale of goods

that is used to calculate gross income and

is technically not a deduction that is applied against gross income in determining taxable income. See §§1.61-3(a) and

1.263A-1(e)(3)(ii)(I) and (J). Thus, proposed §1.163(j)-1(b)(1)(iii) provides that

depreciation, amortization, or depletion

expense capitalized into inventory under

section 263A is not a depreciation, amortization, or depletion deduction, that may

be added back to taxable income in computing ATI. The preamble to the proposed

regulations further noted that an amount

that is incurred as depreciation, amortization, or depletion, but that is capitalized

to inventory under section 263A and included in costs of goods sold, is not a deduction for depreciation, amortization, or

depletion for purposes of section 163(j).

Many commenters raised questions and

concerns regarding proposed §1.163(j)1(b)(1)(iii) and requested that the addback

of deductions for depreciation, amortization, and depletion include any amount

that is required to be capitalized into inventory under section 263A. First, commenters stated that the provision does not

reflect congressional intent, which was

to determine ATI using earnings before

interest, tax, depreciation, and amortiza-

Consistent with section 163(j)(8), proposed §1.163(j)-1(b)(1) defines ATI as the

“taxable income” of the taxpayer for the

taxable year, with certain specified adjustments. Thus, in calculating ATI, the

proposed regulations begin with taxable

income as the amount to which adjustments are made when calculating ATI.

Proposed §1.163(j)-1(b)(37)(i) generally

provides that the term “taxable income”

has the meaning provided in section 63,

but for purposes of section 163(j), is computed without regard to the application

of section 163(j) and the section 163(j)

regulations. However, in some instances

in the section 163(j) regulations the term

“taxable income” is used to indicate the

amount calculated under section 63 for

purposes other than calculating ATI.

To prevent confusion from using the

term “taxable income” in different contexts (in determining ATI, and for purposes other than determining ATI), the final

regulations use a new term, “tentative

taxable income,” to refer to the amount to

which adjustments are made in calculating ATI. See §1.163(j)-1(b)(43). Tentative

taxable income is generally determined in

the same manner as taxable income under

section 63, but is computed without regard

to the application of the section 163(j)

limitation, and without regard to any disallowed business interest expense carryforwards. This definitional change avoids

confusion with section 63 taxable income,

avoids creating an iterative loop that takes

into account the section 163(j) limitation,

and ensures that disallowed business interest expense carryforwards are taken

into account only once in testing business

interest expense against the limitation.

Therefore, “tentative taxable income”

is used in the final regulations and, where

appropriate, in this Summary of Comments and Explanation of Provisions section, to describe the starting point for the

calculation of ATI in the final regulations.

See part II(G)(1) of this Summary of

Comments and Explanation of Revisions

section.

620

Bulletin No. 2020–40

tion (EBITDA) through taxable year 2021

and using earnings before interest and tax

(EBIT) thereafter. Commenters noted that

the proposed rule would eliminate this

distinction for certain manufacturers or

producers of property for sale. Commenters pointed out that capital-intensive businesses that manufacture or produce inventory are at a disadvantage in comparison

to other types of businesses because the

manufacturers or producers would have

to compute ATI without an addback for a

substantial amount of their depreciation,

and that neither section 163(j) nor its legislative history indicates an intent by Congress to treat manufacturers or producers

of inventory differently from other trades

or businesses. Commenters also contrasted the language in section 163(j)(8)(A)

(iv), which allows an addback of “the

amount of any deduction allowed under

section 199A,” with section 163(j)(8)(A)

(v), which allows an addback of “any deduction allowable for depreciation, amortization, or depletion” (emphasis added).

The phrase “allowed or allowable” is

used in other Code provisions. Section

1016(a)(2) provides that, in calculating

tax basis, adjustments are required for depreciation to the extent such amounts are

allowed as deductions in computing taxable income but not less than the amounts

allowable. Some commenters noted that

depreciation allowable as a deduction for

purposes of section 1016(a)(2) should be

read consistently with depreciation allowable as a deduction for purposes of section

163(j), and that section 1016(a)(2) treats

depreciation capitalized into inventory under section 263A as deductions allowable.

As provided in section 263A(a)(2) and

§1.263A-1(c)(2), an amount is not subject

to capitalization under section 263A unless such cost may be taken into account

in computing taxable income.

The Treasury Department and the IRS

have reconsidered proposed §1.163(j)1(b)(1)(iii). Accordingly, under the final

regulations, the amount of any depreciation, amortization, or depletion that is capitalized into inventory under section 263A

during taxable years beginning before

January 1, 2022, is added back to tentative

taxable income as a deduction for depreciation, amortization, or depletion when calculating ATI for that taxable year, regardless of the period in which the capitalized

Bulletin No. 2020–40

amount is recovered through cost of goods

sold. For example, if a taxpayer capitalized an amount of depreciation to inventory under section 263A in the 2020 taxable

year, but the inventory is not sold until the

2021 taxable year, the entire capitalized

amount of depreciation is added back to

tentative taxable income in the 2020 taxable year, and such capitalized amount of

depreciation is not added back to tentative

taxable income when the inventory is sold

and recovered through cost of goods sold

in the 2021 taxable year. Under such facts,

the entire capitalized amount is deemed to

be included in the calculation of the taxpayer’s tentative taxable income for the

2020 taxable year, regardless of the period

in which the capitalized amount is actually recovered. See §§1.163(j)-1(b)(1)(iii)

and 1.163(j)-2(h)(3).

Further, in order to treat similarly situated taxpayers similarly, the final regulations allow taxpayers, and their related

parties within the meaning of sections

267(b) and 707(b)(1), otherwise relying

on the proposed regulations in their entirety under §1.163(j)-1(c) to alternatively choose to follow §1.163(j)-1(b)(1)(iii)

rather than proposed §1.163(j)-1(b)(1)

(iii). See §1.163(j)-1(c).

The Treasury Department and the IRS

note that neither proposed §1.163(j)-1(b)

(1) nor §1.163(j)-1(b)(1) determines the

amount of allowed or allowable depreciation, amortization, or depletion for purposes of any other Code section (for example,

sections 167(c), 1016(a)(2), 1245, and

1250). Accordingly, no inference should

be drawn regarding the determination of

the amount of allowed or allowable depreciation, amortization, or depletion under

any other Code section based on proposed

§1.163(j)-1(b)(1) or §1.163(j)-1(b)(1).

In addition to comments about whether

depreciation, amortization, and depletion

include amounts recovered through cost

of goods sold, a commenter requested

clarification that section 179 deductions

are depreciation deductions for purposes

of section 163(j)(8)(A)(v) and proposed

§1.163(j)-1(b)(1)(i)(D). Section 179 deductions are allowed to be added back as

amortization under proposed §1.163(j)1(b)(1)(i)(E), which allows an addback of

any deduction for the amortization of intangibles (for example, under section 167

or 197) and other amortized expenditures

621

(for example, under section 195(b)(1)(B),

248, or 1245(a)(2)(C)), for taxable years

beginning before January 1, 2022. Section

1245(a)(2)(C) provides “any deduction allowable under sections 179, 179B, 179C,

179D, 179E, 181, 190, 193, or 194 shall

be treated as if it were a deduction allowable for amortization.” Because section

179 deductions are included as amortization under proposed §1.163(j)-1(b)(1)(i)

(E), rather than as depreciation under proposed §1.163(j)-1(b)(1)(i)(D), no clarification is necessary in the final regulations.

See §1.163(j)-1(b)(1)(i)(E).

3. ATI and Floor Plan Financing Interest

Consistent with section 163(j)(8)(A)

(ii), the proposed regulations provide that

any business interest expense or business

interest income is added back to (in the

case of business interest expense) or subtracted from (in the case of business interest income) taxable income in computing

ATI. Because business interest expense

includes floor plan financing interest expense, ATI is further adjusted by subtracting from it any floor plan financing interest expense under proposed §1.163(j)-1(b)

(1)(ii)(B). Floor plan financing interest

expense is also separately included in the

section 163(j) limitation as provided in

section 163(j)(1)(C).

One commenter suggested that floor

plan financing interest expense should

not be subtracted from ATI because such

adjustment is inconsistent with the statute and the ordering implied by section

168(k)(9)(B). The addition of floor plan

financing interest expense as business

interest in the calculation of ATI is consistent with section 163(j)(8)(A)(ii). The

purpose of subtracting floor plan financing interest expense from tentative taxable income to compute ATI is to avoid

the double benefit that would result upon

separately including floor plan financing

interest expense in the computation of

the section 163(j) limitation. If floor plan

financing interest expense were included

in ATI without a corresponding subtraction, thus resulting in an increased ATI,

taxpayers with such expense would be

able to increase their section 163(j) limitation not only by the separately stated

floor plan financing interest under section

163(j)(1)(C), but also by the inclusion of

September 28, 2020

such amount in ATI, which would permit

a deduction of $1.30 (or $1.50, if the 50

percent ATI limitation is applicable) of

business interest expense for each $1 of

floor plan financing interest expense. Although it is clear that Congress did not intend to limit the deduction for floor plan

financing interest expense under section

163(j), there is no indication that Congress also intended to provide the additional benefit of an increased ATI related

to floor plan financing interest expense.

Therefore, under the authority granted in

section 163(j)(8)(B), the final regulations

adopt the proposed rule without change

to include a subtraction of floor plan financing interest expense from tentative

taxable income in computing ATI.

Several commenters also requested

clarification and submitted recommendations on the interaction between section

168(k)(9) and section 163(j). Section

168(k)(9)(B) provides that the additional

first-year depreciation deduction is not allowed for any property used in a trade or

business that has had floor plan financing

indebtedness (as defined in section 163(j)

(9)), if the floor plan financing interest related to such indebtedness was taken into

account under section 163(j)(1)(C).

First, commenters requested that floor

plan financing indebtedness not be treated

as taken into account if the sum of business interest income and 30 percent of

ATI (the sum of section 163(j)(1)(A) and

section 163(j)(1)(B)) is greater than the

business interest expense paid or accrued

in the taxable year. Second, if the sum of

business interest income and 30 percent of

ATI is less than the business interest expense paid or accrued in the taxable year,

commenters requested that taxpayers be

given the option to either include floor

plan financing interest to increase the section 163(j) limitation, or to forgo the use

of floor plan financing interest to increase

the section 163(j) limitation (any forgone

floor plan financing interest would be included in the disallowed business interest

expense carryforward under proposed

§1.163(j)-2(c)) in order to utilize the additional first-year depreciation deduction

under section 168(k).

Section 163(j) does not provide any

guidance on the availability of section

168(k) for taxpayers that have had floor

plan financing interest expense. As these

September 28, 2020

comments relate to the operation of section 168(k)(9), taxpayers should look to

Treasury Department or IRS guidance

provided under section 168(k) for clarification. On September 24, 2019, the Treasury Department and the IRS published

in the Federal Register final regulations

(TD 9874, 84 FR 50108) and proposed

regulations (REG-106808-19, 84 FR

50152) under section 168(k). The rules

regarding when floor plan financing interest expense is “taken into account” for

purposes of 168(k) are in the proposed

regulations under §1.168(k)-2(b)(2)(ii)

(G). Accordingly, these final regulations

do not address the interaction between

section 163(j) and section 168(k)(9) regarding floor plan financing interest expense.

4. Adjustments to Taxable Income in

Computing ATI Under Section 163(j)(8)

(A)

Section 163(j)(8)(A) provides that ATI

means taxable income “computed without regard to” the specified adjustments.

The purpose of the adjustments listed in

section 163(j)(8)(A) is to keep certain

items, such as deductions for depreciation, amortization, depletion, or NOL

carryforward amounts, from directly increasing or decreasing the amount of the

deduction for business interest expense.

Therefore, the Treasury Department and

the IRS have determined that the adjustments listed in section 163(j)(8)(A)

should adjust tentative taxable income

for purposes of calculating ATI under

§1.163(j)-1(b)(1) only to the extent that

they have been reflected (or deemed reflected, as in the case of certain amounts

capitalized into inventory under section

263A as discussed in part II(A)(2) of this

Summary of Comments and Explanation

of Revisions section) in tentative taxable

income under §1.163(j)-1(b)(43).

A commenter requested that the definition of ATI not include some of the adjustments listed in section 163(j)(8)(A), such

as the adjustments for NOL deductions

and deductions under section 199A. The

Treasury Department and the IRS do not

have authority to ignore these clear and

unambiguous statutory adjustments. Thus,

the final regulations do not incorporate the

commenter’s suggestion.

622

5. Certain Adjustments to Tentative

Taxable Income in Computing ATI Under

Section 163(j)(8)(B)

Under the authority granted in section

163(j)(8)(B), the proposed regulations

include several adjustments to taxable income in computing ATI to address certain

sales or other dispositions of depreciable

property, stock of a consolidated group

member, or interests in a partnership. Proposed §1.163(j)-1(b)(1)(ii)(C) provides

that, if property is sold or otherwise disposed of, the lesser of the amount of gain

on the disposition or the amount of depreciation, amortization, or depletion deductions (collectively, depreciation deductions) with respect to the property for the

taxable years beginning after December

31, 2017 and before January 1, 2022 (such

years, the EBITDA period) is subtracted

from taxable income to determine ATI.

Proposed §1.163(j)-1(b)(1)(ii)(D) provides that, with respect to the sale or other

disposition of stock of a member of a consolidated group that includes the selling

member, the investment adjustments (see

§1.1502-32) with respect to such stock that

are attributable to deductions described

in proposed §1.163(j)-1(b)(1)(ii)(C) are

subtracted from taxable income. In turn,

proposed §1.163(j)-1(b)(1)(ii)(E) provides that, with respect to the sale or other

disposition of an interest in a partnership,

the taxpayer’s distributive share of deductions described in proposed §1.163(j)-1(b)

(1)(ii)(C) with respect to property held by

the partnership at the time of such disposition is subtracted from taxable income to

the extent such deductions were allowable

under section 704(d).

In general, when a taxpayer takes depreciation deductions with respect to an

asset, the taxpayer must reduce its adjusted basis in the asset accordingly. As a

result, the taxpayer will realize additional

gain (or less loss) upon the subsequent

disposition of the asset than the taxpayer

would have realized absent depreciation

deductions. Thus, except with regard to

timing (and, in some cases, character), depreciation deductions should have no net

effect on a taxpayer’s taxable income.

In order to mitigate the effects of the

section 163(j) limitation during the EBITDA period, Congress provided an adjustment to taxable income for depreciation

Bulletin No. 2020–40

deductions. More specifically, as discussed in part II(A)(2) of this Summary of

Comments and Explanation of Revisions

section, depreciation deductions are added

back to taxable income during the EBITDA period, thereby increasing a taxpayer’s ATI and its section 163(j) limitation.

Congress intended this adjustment to be a

timing provision that delays the inclusion

of depreciation deductions in calculating a

taxpayer’s section 163(j) limitation. Stated differently, Congress intended to allow

taxpayers to accelerate the recognition of

gain attributable to depreciation deductions when computing ATI.

However, if a taxpayer were to sell

its depreciable property after making the

foregoing adjustment to ATI, the taxpayer would realize additional gain (or less

loss) on the disposition as a result of its

depreciation deductions, and the taxpayer’s ATI would be increased yet again.

Similarly, if the depreciable property were

held by a member of a consolidated group

(S), and if another member of the group

were to sell S’s stock after making negative adjustments to its basis in S’s stock

under §1.1502-32 to reflect S’s depreciation deductions, the consolidated group’s

ATI would be increased yet again. A similar double benefit would arise with respect

to interests in a partnership if, after the

partner’s basis in its partnership interest is

reduced by depreciation deductions associated with the depreciable property, ATI

were to reflect that reduced basis upon a

subsequent sale of the partnership interest.

Proposed §1.163(j)-1(b)(1)(ii)(C), (D),

and (E) were intended to address these situations and ensure that the positive adjustment for depreciation deductions during

the EBITDA period merely defers (rather

than permanently excludes) depreciation

deductions from a taxpayer’s calculation

of the section 163(j) limitation.

Commenters submitted various questions and comments about these provisions. First, a commenter questioned

whether these proposed subtractions from

taxable income are an advisable exercise

of the authority granted in section 163(j)

(8)(B) in light of congressional silence on

the issue. However, the 1991 Proposed

Regulations contained similar subtractions from taxable income in computing

ATI. The 1991 Proposed Regulations had

been outstanding for more than 25 years

Bulletin No. 2020–40

when Congress enacted the TCJA. Thus,

Congress likely was well aware of these

adjustments when it granted the Secretary of the Treasury the authority to make

adjustments in new section 163(j)(8)(B).

Moreover, there is no indication that Congress intended to preclude the Secretary

from making adjustments similar to those

in the 1991 Proposed Regulations.

Second, commenters asked why the

subtraction from taxable income in proposed §1.163(j)-1(b)(1)(ii)(D) does not

include a “lesser of” calculation similar

to proposed §1.163(j)-1(b)(1)(ii)(C), and

they questioned whether the “lesser of”

calculation in proposed §1.163(j)-1(b)(1)

(ii)(C) captures the correct amount. For

example, if a taxpayer purchased property for $100x, fully depreciated the property, and then sold the property for $60x,

should the amount that is backed out under

proposed §1.163(j)-1(b)(1)(ii)(C) be $60x

or $100x? Commenters also stated that

the presence of a “lesser of” limitation in

proposed §1.163(j)-1(b)(1)(ii)(C) and the

absence of such a limitation in proposed

§1.163(j)-1(b)(1)(ii)(D) can yield discontinuities. For example, if S (a member

of P’s consolidated group) uses $50x to

purchase an asset that it fully depreciates

under section 168(k) (resulting in a $50x

reduction in P’s basis in its S stock under

§1.1502-32), and if S sells the depreciated asset for $25x the following year, the

P group would have to subtract $25x from

taxable income under proposed §1.163(j)1(b)(1)(ii)(C), whereas the group would

have had to reduce its taxable income by

$50x under proposed §1.163(j)-1(b)(1)(ii)

(D) if P had sold its S stock instead. Commenters recommended several solutions

to address this discontinuity, including

eliminating the “lesser of” test.

Proposed §1.163(j)-1(b)(1)(ii)(D) does

not include a “lesser of” calculation because such a calculation would require

consolidated groups to value their assets

each time there is a sale of member stock.

However, the Treasury Department and

the IRS recognize the discrepancy in taxable income adjustments between asset

dispositions and member stock dispositions under the proposed regulations. To

eliminate this discrepancy, the final regulations revise proposed §1.163(j)-1(b)

(1)(ii)(C) by eliminating the “lesser of”

standard and requiring taxpayers to back

623

out depreciation deductions that were allowed or allowable during the EBITDA

period with respect to sales or dispositions of property. This revised approach

is consistent with the adjustment for asset

sales in the 1991 Proposed Regulations, is

simpler for taxpayers to administer than

the “lesser of” approach in the proposed

regulations, and renders moot questions

as to whether that “lesser of” calculation

captures the correct amount. However,

the Treasury Department and the IRS also

recognize that, in certain cases, a “lesser

of” computation would not be difficult to

administer. Thus, the Concurrent NPRM

provides taxpayers the option to apply the

“lesser of” standard, so long as they do so

consistently. See proposed §1.163(j)-1(b)

(1)(iv)(E) of the Concurrent NPRM.

Third, commenters asked whether the

application of proposed §1.163(j)-1(b)(1)

(ii)(C) and (D) to the same consolidated

group member would result in an inappropriate double inclusion if the asset

sale precedes the stock sale, and whether

proposed §1.163(j)-1(b)(1)(ii)(C) should

continue to apply to a group member if

the sale of member stock precedes the

asset sale. For example, S (a member of

P’s consolidated group) takes a $50x depreciation deduction in 2020 with respect

to asset X, P’s basis in its S stock is reduced accordingly under §1.1502-32, and

$50x is added back to the P group’s tentative taxable income in computing its 2020

ATI. In 2021, S realizes a $50x gain upon

the sale of asset X, P’s basis in its S stock

is increased accordingly by $50x under

§1.1502-32, and the P group subtracts

$50x from its tentative taxable income

under proposed §1.163(j)-1(b)(1)(ii)(C)

in computing its 2021 ATI. Then, in 2022,

P sells the S stock to an unrelated buyer.

Must P subtract another $50x from its

tentative taxable income under proposed

§1.163(j)-1(b)(1)(ii)(D)? What if the order of sales were reversed (with P selling

its S stock to a member of another consolidated group in 2021 and S selling asset X in 2022)—would both consolidated

groups be required to subtract $50x from

tentative taxable income in computing

ATI? To prevent duplicative adjustments

under proposed §1.163(j)-1(b)(1)(ii)(C)

and (D), commenters recommended that

these rules “turn off” further subtractions

once a subtraction already has been made

September 28, 2020

under either provision, and that the application of proposed §1.163(j)-1(b)(1)(ii)

(C) be limited to the group in which the

depreciation deductions accrued.

The Treasury Department and the IRS

agree that the application of §1.163(j)1(b)(1)(ii)(C) and (D) to the same consolidated group member would result in

an inappropriate double inclusion, and

that proposed §1.163(j)-1(b)(1)(ii)(C)

should not apply to a former group member with respect to depreciation deductions claimed by the member in a former

group. Thus, §1.163(j)-1(b)(1)(iv)(D)

provides anti-duplication rules to ensure

that neither §1.163(j)-1(b)(1)(ii)(C) nor

§1.163(j)-1(b)(1)(ii)(D) applies if a subtraction for the same economic amount

already has been required under either

provision.

For example, assume that P wholly

owns S1, which wholly owns S2, which

owns depreciable asset Q, and that S1

and S2 are members of P’s consolidated

group. Further assume that S2’s depreciation deductions with respect to asset Q

have resulted in investment adjustments

in S1’s stock in S2 and in P’s stock in

S1. If S1 were to sell its S2 stock to a

third party, adjustments to the P group’s

tentative taxable income would be required under proposed §1.163(j)-1(b)(1)

(ii)(D). If P later were to sell its S1 stock

to a third party, an additional adjustment

under proposed §1.163(j)-1(b)(1)(ii)(D)

would not be required with respect to

investment adjustments attributable to

asset Q.

Fourth, commenters observed that

these proposed subtractions from taxable

income in computing ATI are required

even if the disposition of the depreciable

property, member stock, or partnership

interest occurs many years after the EBITDA period. Commenters expressed concern that tracking depreciation deductions

for purposes of these adjustments could

become burdensome, and a commenter

questioned the appropriateness in proposed §1.163(j)-1(b)(1)(ii)(C) of treating

all gain upon the disposition of property

after the EBITDA period as attributable to

depreciation deductions during the EBITDA period.

Commenters are correct in observing

that these proposed adjustments to taxable income in computing ATI must be

September 28, 2020

made even if the relevant depreciable asset, member stock, or partnership interest

is disposed of after the EBITDA period.

However, the Treasury Department and

the IRS note that members of consolidated groups already must track depreciation deductions to calculate separate

taxable income (see §1.1502-12) and to

preserve the location of tax items (see

§1.1502-13). Additionally, all taxpayers

must track depreciation deductions on

an asset-by-asset basis for purposes of

section 1245. Thus, the Treasury Department and the IRS have determined that

the adjustments proposed in §1.163(j)1(b)(1)(ii)(C), (D), and (E) should not

impose a significant administrative burden in many situations. The Treasury

Department and the IRS further note that

eliminating the “lesser of” standard in

proposed §1.163(j)-1(b)(1)(ii)(C) (see

the response to the second comment in

this part of the Summary of Comments

and Explanation of Revisions section)

will render moot the commenter’s concern about the calculation of gain.

Fifth, a commenter asked whether the

term “sale or other disposition” in proposed §1.163(j)-1(b)(1)(ii)(C), (D), and

(E) is intended to apply to the transfer of

stock of a consolidated group member in

an intercompany transaction (within the

meaning of §1.1502-13(b)(1)(i)) or to

the transfer of assets in a nonrecognition

transaction to which section 381 applies (a

section 381 transaction).

As provided in proposed §1.163(j)4(d)(2), a consolidated group has a single

section 163(j) limitation, and intercompany items and corresponding items are

disregarded for purposes of calculating

the group’s ATI to the extent they offset in

amount. The Treasury Department and the

IRS have determined that regarding intercompany items and corresponding items

for purposes of §1.163(j)-1(b)(1)(ii)(C)

and (D) would be inconsistent with this

general approach. Thus, §1.163(j)-1(b)(1)

(iv)(A)(2) provides that an intercompany transaction should not be treated as a

“sale or other disposition” for purposes of

§1.163(j)-1(b)(1)(ii)(C) and (D).

In turn, the transfer of depreciable assets in a section 381 transaction generally

should not be treated as a “sale or other

disposition” because the transfer does not

affect ATI and because the transferee cor-

624

poration is the successor to the transferor

corporation. Thus, the final regulations

generally provide that a transfer of an asset to an acquiring corporation in a transaction to which section 381(a) applies

is not treated as a “sale or other disposition” for purposes of §1.163(j)-1(b)(1)(ii)

(C), (D), and (E). However, if a member

leaves a consolidated group, that transaction generally is treated as a sale or other

disposition under the final regulations for

purposes of §1.163(j)-1(b)(1)(ii)(C) and

(D), regardless of whether the transaction

is a section 381 transaction, because the

adjustment to ATI under these provisions

should be reflected on the tax return of the

group that received the benefit of the earlier increase in ATI.

Sixth, a commenter asked for clarification as to when the adjustment in proposed §1.163(j)-1(b)(1)(ii)(D) is required

and which investment adjustments under

§1.1502-32 are treated as “attributable to”

depreciation deductions for purposes of

this provision. For example, P wholly and

directly owns both S and S1 (members of

P’s consolidated group). In 2021, S purchases asset X for $100x and fully depreciates asset X under section 168(k), and P

reduces its basis in its S stock by $100x

under §1.1502-32. In 2022, P contributes

the stock of S to S1 in an intercompany

transaction (which, as noted previously,

is not treated as a “sale or other disposition” for purposes of proposed §1.163(j)1(b)(1)(ii)(C) and (D)). If P later sells the

S1 stock, is the adjustment in proposed

§1.163(j)-1(b)(1)(ii)(D) required even

though no adjustment to P’s basis in the

S1 stock under §1.1502-32 is “attributable

to” the $100x of depreciation deductions

taken with respect to asset X?

The Treasury Department and the

IRS have determined that the adjustment

to tentative taxable income in proposed

§1.163(j)-1(b)(1)(ii)(D) should apply in

the foregoing situation. The final regulations have been revised to provide that,

for these purposes, P’s stock in S1 would

be treated as a successor asset (within the

meaning of §1.1502-13(j)(1)) to P’s stock

in S.

Seventh, commenters stated that there

should be no adjustments to taxable income under proposed §1.163(j)-1(b)(1)

(ii)(C), (D), and (E) if and to the extent

that adding back depreciation deductions

Bulletin No. 2020–40

pursuant to section 163(j)(8)(A)(v) and

proposed §1.163(j)-1(b)(1)(i) did not increase the amount of business interest

expense the taxpayer could have deducted

in the year the deductions were incurred.

For example, in 2021, corporation C has

$500x of ATI (computed by adding back

$50x of depreciation deductions with respect to asset X) and $100x of business

interest expense. Without adding back the

depreciation deductions, C’s ATI would

have been $450x, C’s section 163(j) limitation would have been $135x ($450x

x 30 percent), and C still could have deducted all $100x of its business interest

expense in that year. In 2022, C has $90x

of business interest expense and $300x of

ATI. C sells asset X for a $50x gain in that

year. If C were required to reduce its ATI

by $50x (from $300x to $250x) in 2022

under proposed §1.163(j)-1(b)(1)(ii)(C),

its section 163(j) limitation would be reduced to $75x ($250x x 30 percent), and

C would not be able to deduct all $90x of

its business interest expense in 2022 even

though C derived no benefit from adding

back its depreciation deductions to taxable

income in 2021.

The Treasury Department and the IRS

have determined that predicating the

application of proposed §1.163(j)-1(b)

(1)(ii)(C), (D), and (E) upon whether a

taxpayer derived a benefit under section

163(j) from adding back its depreciation

deductions to taxable income would involve significant additional complexity.

In addition, this approach would have an

effect similar to allowing a carryforward

of these amounts to the taxable year in

which gain on the related items is recognized on a sale or other disposition.

Such a carryforward is inconsistent with

the general approach of section 163(j),

which does not permit a carryforward

of excess ATI to later taxable years. As

noted earlier in this part II(A)(5) of this

Summary of Comments and Explanation

of Revisions section, depreciation deductions should have no net effect on the

amount of a taxpayer’s taxable income

(except with respect to timing and, perhaps, character). Thus, if a taxpayer sells

an asset with respect to which the taxpayer has taken depreciation deductions,

the increase in gain (or decrease in loss)

upon the sale should be reversed under

proposed §1.163(j)-1(b)(1)(ii)(C).

Bulletin No. 2020–40

6. Adjustments to Adjusted Taxable

Income in Respect of United States

Shareholders of CFCs

Some commenters argued that United

States shareholders, as defined in section

951(b) (U.S. shareholders), of controlled

foreign corporations, as defined in section

957(a) (CFCs), should be allowed to include in their ATI the amounts included in

gross income under section 951(a) (subpart F inclusions), section 951A(a) global intangible low-taxed income (GILTI)

inclusions, and section 78 “gross-up” inclusions (collectively, CFC income inclusions) attributable to non-excepted trades

or businesses. Because section 163(j) applies to CFCs, the Treasury Department

and the IRS have determined that allowing a U.S. shareholder to include its CFC

income inclusions in its ATI would not be

appropriate. The income of the CFC that

gives rise to such income is taken into account in computing the ATI of the CFC for

purposes of determining its section 163(j)

limitation, and allowing the same income

to also be taken into account in computing the ATI of a U.S. shareholder would

result in an inappropriate double-counting

of income.

Furthermore, the Treasury Department

and the IRS question the premise of several comments that, if the business interest

expense of a CFC were excluded from the

application of section 163(j), including the

income of a CFC in a U.S. shareholder’s

ATI would be appropriate. Even if section

163(j) did not apply to CFCs, CFCs are

entities that also may be leveraged. Thus,

permitting the income of the CFC that

gives rise to CFC income inclusions attributable to non-excepted trades or businesses of CFCs to be included in the ATI

of U.S. shareholders would be inconsistent with the principles of section 163(j).

In particular, consider a case in which a

CFC has interest expense of $100x, trade

or business gross income of $300x treated as subpart F income, and no foreign

tax liability. In such a case, a U.S. shareholder that wholly owns the CFC would

have a subpart F inclusion of $200x (if

section 163(j) did not apply to CFCs). If

the $200x subpart F inclusion were included in the ATI of the U.S. shareholder,

the U.S. shareholder could deduct an additional $60x of business interest expense

625

($200x x 30 percent). As a result, $300x

of gross income could support $160x of

interest expense deductions rather than the

$90x permitted under section 163(j)(1).

Finally, under the final regulations (and

consistent with proposed §1.163(j)-7(d)

(1)(ii)), if a domestic partnership includes

amounts in gross income under sections

951(a) and 951A(a) with respect to an

applicable CFC and such amounts are investment income to the partnership, then,

a domestic C corporation partner’s distributive share of such amounts that are properly allocable to a non-excepted trade or

business of the domestic C corporation by

reason of §§1.163(j)-4(b)(3) and 1.163(j)10(c) are excluded from the domestic C

corporation partner’s ATI.

B. Definition of Business Interest

Expense – Proposed §1.163(j)-1(b)(2)

The proposed regulations provide that

business interest expense includes interest

expense allocable to a non-excepted trade

or business, floor plan financing interest

expense, and disallowed business interest

expense carryforwards. The Treasury Department and the IRS received informal

questions about the interaction between

section 163(j) and sections 465 and 469,

which may operate to disallow a deduction for business interest expense even

if such expense was allowable after the

application of section 163(j). More specifically, questions have arisen regarding

how to treat amounts of business interest

expense that are disallowed under section

465 or 469, including which amounts carry forward to subsequent taxable years but

keep their character as interest expense,

and which amounts, if any, are business

interest expense in such subsequent taxable years.

If amounts of business interest expense that are disallowed under section

465 or 469 are treated as business interest expense in subsequent taxable years,

the section 163(j) limitation could operate to disallow a deduction even though

such amounts were allowable in the prior

taxable year after application of the section 163(j) limitation. The Treasury Department and the IRS do not intend such

a result. Therefore, the final regulations

clarify that amounts allowable as a deduction after application of the section 163(j)

September 28, 2020

limitation but disallowed by section 465

or 469 are not business interest expense

subject to the section 163(j) limitation in

subsequent taxable years.

C. Definition of Excepted Regulated

Utility Trade or Business – Proposed

§1.163(j)-1(b)(13)

Numerous comments were submitted

concerning the definition of an “excepted

regulated utility trade or business” under

proposed §1.163(j)-1(b)(13). Proposed

§1.163(j)-1(b)(13), which implements

the exception in section 163(j)(7)(A)(iv)

to the definition of a “trade or business,”

generally provides that an excepted regulated utility trade or business is a trade or

business that sells or furnishes the items

listed in section 163(j)(7)(A)(iv) at rates

that are established or approved by certain

regulatory bodies described in proposed

§1.163(j)-1(b)(13)(i)(B)(1) and (2).

The proposed regulations provide that

utilities that sell or furnish the regulated

items at rates that are established or approved by a regulatory body described in

proposed §1.163(j)-1(b)(13)(i)(B)(1), other than an electric cooperative, are considered to be excepted only to the extent that

such rates are determined on a “cost of

service and rate of return” basis. The “cost

of service and rate of return” requirement

was intended to provide certainty to taxpayers because many utilities are familiar

with the definition of “cost of service and

rate of return,” which is used to determine

whether a public utility company must use

a normalization method of accounting under section 168 for certain properties.

However, several commenters questioned whether a “cost of service and rate

of return” requirement would be satisfied

in specific fact patterns. Commenters

questioned whether certain negotiated

rates are established or approved on a

“cost of service and rate of return” basis

if (1) the applicable regulatory body has

the authority to impose a cost-based rate

instead of the negotiated rate, (2) the rates

are computed with reference to cost but

discounted from the recourse (or maximum) rate allowed by the regulatory body,

or (3) the rates are computed with reference to cost and a set rate of return but

are subject to a market-based cap. Commenters also asked whether the inclusion

September 28, 2020

of certain amounts in determining “cost

of service,” specifically the costs of affiliates and some revenues attributable to

market-rate sales, would affect the determination of whether rates are established

or approved on a “cost of service and rate

of return” basis.

One commenter noted that the normalization rules operate logically only in the

“cost of service and rate of return” context. The commenter stated that, because

section 163(j)(7)(A)(iv) does not reference the normalization rules, there is no

need to include the “cost of service and

rate of return” requirement in the section

163(j) regulations.

The Treasury Department and the IRS

note that, in private letter rulings and informal guidance related to section 168(i)

(9) and (10), the IRS has stated that, for

purposes of applying the normalization

rules, the definition of “public utility property” must contain the requirement that

the regulated rates be established or approved on a “rate of return” basis. In this

guidance, the IRS explained that the normalization method, which must be used

for public utility property to be eligible

for the depreciation allowance available

under section 168, is defined in terms of

the method the taxpayer uses in computing its tax expense in establishing its “cost

of service” for ratemaking purposes and

reflecting operating results in its regulated

books of account. Furthermore, the IRS

has issued numerous private letter rulings

regarding whether under the specific facts

of the taxpayer, the cost of service and

rate of return requirement has been met

for purposes of section 168(i). Thus, it is

clear that, in the context of section 168,

the “cost of service and rate of return” requirement is necessary.

Neither the text of section 163(j) nor

the legislative history specifically references the normalization rules or the “cost

of service and rate of return” requirement

under section 168(i)(10). With the omission of such references, the exception in

section 163(j) for regulated utility trade or

business could be applied broadly without reference to specific requirements

applicable in the normalization rules.

However, the Treasury Department and

the IRS note that under section 168(k)

(9), the additional first-year depreciation

deduction is not available to any proper-

626

ty that is primarily used in an excepted

regulated utility trade or business. Therefore, to ease the administrative burden of

determining whether businesses qualify

as excepted regulated utility trades or

businesses, and to allow taxpayers the

option of claiming the additional firstyear depreciation deduction under section 168(k) in lieu of being treated as an

excepted regulated utility trade or business, the final regulations retain the “cost

of service and rate of return” requirement

from the proposed regulations, and also

allow taxpayers to make an election to

be an excepted regulated utility trade or

business to the extent that the rates for the

furnishing or sale of the items described

in §1.163(j)-1(b)(15)(i)(A)(1) have been

established or approved by a regulatory

body described in §1.163(j)-1(b)(15)(i)

(A)(2), if the rates are not determined on

a “cost of service and rate of return” basis. See §1.163(j)-1(b)(15)(i) and (iii).

For purposes of the election, the focus

of section 163(j)(7)(A)(iv) is the phrase

“established or approved” in section

163(j)(7)(A)(iv), which describes the authority of the regulatory body described

in §1.163(j)-1(b)(15)(i)(A)(2). Ratemaking programs similar to those described

by commenters and discussed previously in this part II(C) of this Summary of

Comments and Explanation of Revisions

section, including discounted rates, negotiated rates, and regulatory rate caps, are

established or approved by a regulatory

body if the taxpayer files a schedule of

such rates with a regulatory body that has

the power to approve, disapprove, alter

the rates, or substitute a rate determined in

an alternate manner.

Similar to elections for electing real

property trades or businesses and electing

farming businesses, the election to be an

excepted regulated utility trade or business is irrevocable. Taxpayers making

the election to be an excepted regulated

utility trade or business are not required

to allocate items between regulated utility

trades or businesses that are described in

§1.163(j)-1(b)(15)(i) and trades or businesses that are described in §1.163(j)1(b)(15)(iii)(A) as to which the taxpayer

makes an election because they are treated

as operating an entirely excepted regulated utility trade or business. Electing taxpayers cannot claim the additional first-

Bulletin No. 2020–40

year depreciation deduction under section

168(k).

The rules set forth in the final regulations are limited solely to the determination of an “excepted regulated utility trade

or business” for purposes of section 163(j)

(7)(A)(iv). As a result of this limited application, the rules in the final regulations

are not applicable to the determination of

“public utility property” or the application of the normalization rules within the

meaning of section 46(f), as in effect on

the day before the date of the enactment of

the Revenue Reconciliation Act of 1990,

section 168(i)(9) and (10) and the regulations thereunder, or to the determination

of any depreciation allowance available

under sections 167 and 168.

Comments also were received on the

application of the rules for excepted regulated utility trades or businesses to electric cooperatives. The definition of an

“excepted regulated utility trade or business” under proposed §1.163(j)-1(b)(13)

includes trades or businesses that sell or

furnish the items listed in section 163(j)

(7)(A)(iv) at rates established or approved

by an electric cooperative. Unlike utility

businesses regulated by public authorities, utilities that sell items at rates regulated by a cooperative are not described

in section 168(i)(10). However, there is a

long-standing body of law regulating the

taxation of electric cooperatives. Electric

cooperatives described in section 501(c)

(12) are generally exempt from income

tax but are subject to taxation under section 511. The application of section 163(j)

and the section 163(j) regulations with

respect to exempt electric cooperatives is

governed by proposed §1.163(j)-4(b)(5).

Other electric cooperatives are subject

to taxation under sections 1381 through

1388 in subchapter T of chapter 1 of subtitle A of the Code (subchapter T), except

for certain rural electric cooperatives specifically excluded from subchapter T by

section 1381(a)(2)(C).

Generally, the exception in section

163(j)(7)(A)(iv) for the trade or business

of selling or furnishing items at rates established or approved by the governing

or ratemaking body of an electric cooperative applies both to sales and furnishing by an electric cooperative and to sales

and furnishing to an electric cooperative

by another utility provider, as long as the

Bulletin No. 2020–40

rates for the sale or furnishing have been

established or approved in the manner required by section 163(j). Thus, an electric

cooperative exempt from Federal income

tax under section 501(c)(12) may not be

subject to section 163(j) for the sale or furnishing of electricity due to the operation

of proposed §1.163(j)-4(b)(5), and another utility provider may be in an excepted

regulated utility trade or business to the

extent that it sells electricity to the section

501(c)(12) cooperative at rates established

or approved by the governing or ratemaking body of the cooperative.

A commenter asked whether proposed

§1.163(j)-1(b)(13) requires that, for sales

involving electric cooperatives to qualify

as an excepted regulated utility trade or

business, the rates for the sales be established or approved by the governing or

ratemaking body of an electric cooperative on a “cost of service and rate of return” basis, or if all sales made subject to

a contract or tariff approved by an electric

cooperative’s governing or ratemaking

body would qualify. Under the proposed

regulations, the specific requirement that

rates for the sale or furnishing of items

listed in proposed §1.163(j)-1(b)(13)

(i)(A) be established or approved on a

“cost of service and rate of return” basis did not extend to rates established or

approved by the governing or ratemaking

body of an electric cooperative. These

regulations adopt the proposed rule, and

do not impose a requirement that rates

for the sale or furnishing of items listed

in §1.163(j)-1(b)(15)(i)(A) by an electric

cooperative be established or approved

on a “cost of service and rate of return”

basis.

Comments also were submitted regarding the allocation of tax items between excepted regulated utility trades or businesses and non-excepted trades or businesses.

These comments are discussed with other

comments on proposed §1.163(j)-10 in

part XI of this Summary of Comments and

Explanation of Revisions section.

D. Definition of Floor Plan Financing

Interest Expense – Proposed §1.163(j)1(b)(17)

Commenters recommended that interest paid on commercial financing liabilities or trade financing (in which a taxpayer

627

borrows to fund the purchase or transport

of commodities and then sells the inventory to pay off the debt) should not be subject to section 163(j). Commenters noted

that trade financing is different from normal financing because it is short-term and

backed by inventory that is monetizable

(rather than plant and equipment). Thus,

commenters suggested that section 163(j)

should not apply to trade financing because there is no depreciation trade-off for

inventory purchased with trade financing.

Commenters compared trade financing

to floor plan financing (because both are

used to finance the purchase of inventory), and they noted that the 1991 Proposed

Regulations under old section 163(j) excluded commercial financing liabilities

from debt taken into account for purposes

of applying the debt-equity ratio under old

section 163(j). See 1991 Proposed Regulations §1.163(j)-3(b)(2)(ii).

The Treasury Department and the IRS

decline to exclude commercial financing

liabilities from the section 163(j) limitation. Section 163(j) does not contain a

provision analogous to the debt-equity ratio safe harbor that was present in old section 163(j) and for which rules were proposed in the 1991 Proposed Regulations.

In addition, because Congress specifically

excluded interest paid on floor plan financing from the section 163(j) limitation, but not all commercial financing liabilities and trade financing, Congress does

not appear to have intended to exclude all

commercial financing liabilities from the

section 163(j) limitation.

E. Definition of Interest – Proposed

§1.163(j)-1(b)(20)

1. In General

Commenters submitted numerous

comments on the definition of “interest”

in the proposed regulations. Proposed

§1.163(j)-1(b)(20) contains a relatively

broad definition of the term “interest” for

purposes of section 163(j). This definition

was proposed to provide a complete definition of interest that addresses all transactions that are commonly understood to

produce interest income and expense, including transactions that otherwise may

have been entered into to avoid the application of section 163(j).

September 28, 2020

Under the proposed regulations, the

term “interest” means any amount described in one of four categories. First,

proposed §1.163(j)-1(b)(20)(i) generally

provides that interest is an amount paid,

received, or accrued as compensation for

the use or forbearance of money under the

terms of an instrument or contractual arrangement, including a series of transactions, that is treated as a debt instrument,

or an amount that is treated as interest under other provisions of the Code or the Income Tax Regulations. For example, this

category includes qualified stated interest,

original issue discount (OID), and accrued

market discount. Commenters agree that

this definition of interest has long been

accepted, is consistent with longstanding

precedent, and reduces the risk of inconsistency within the Code and regulations.

No commenters requested any changes

to this category, and the final regulations

adopt this category in the definition of the

term “interest” without any substantive

changes.

Second, proposed §1.163(j)-1(b)(20)

(ii) treats a swap (other than a cleared

swap) with significant nonperiodic payments as two separate transactions consisting of an on-market, level payment

swap and a loan. Under the proposed regulations, the time value component of the

loan is recognized as interest expense to

the payor and as interest income to the recipient. Several comments were received

on this category in the definition and are

described in part II(E)(2) of this Summary

of Comments and Explanation of Revisions section.

Third, proposed §1.163(j)-1(b)(20)(iii)

treats as interest certain amounts that are

closely related to interest and that affect

the economic yield or cost of funds of a

transaction involving interest, but that

may not be compensation for the use or

forbearance of money on a stand-alone

basis. For example, this category includes

substitute interest payments, debt issuance costs, commitment fees, and hedging

gains and losses that affect the yield of

a debt instrument. Numerous comments

were received on this category and are described in part II(E)(3) of this Summary of

Comments and Explanation of Revisions

section.

Fourth, proposed §1.163(j)-1(b)(20)

(iv) provides an anti-avoidance rule.

September 28, 2020

Under this rule, an expense or loss predominantly incurred in consideration of

the time value of money in a transaction

or series of integrated or related transactions in which a taxpayer secures the use

of funds for a period of time is treated as

interest expense for purposes of section

163(j). Numerous comments were received on this category and are described

in part II(E)(4) of this Summary of Comments and Explanation of Revisions section.

2. Swaps with Significant Nonperiodic

Payments

The proposed regulations treat a noncleared swap with significant nonperiodic payments as two separate transactions

consisting of an on-market, level payment

swap and a loan (the embedded loan rule).

The embedded loan rule did not apply to

a collateralized swap that was cleared by

a derivatives clearing organization or by

a clearing agency (a cleared swap) because the treatment of cleared swaps was

reserved. In the preamble to the proposed

regulations, the Treasury Department and

the IRS requested comments on the proper treatment of collateralized swaps under

the embedded loan rule.

One commenter recommended that the

final regulations provide an exception to

the embedded loan rule for cleared swaps

and for non-cleared swaps that are substantially collateralized. This commenter

further suggested that the final regulations

not include any specific rules regarding

the type of collateral that is required to be

posted to qualify for the exception. The

commenter also recommended that the

final regulations provide objective rules

for determining if a nonperiodic payment

is “significant” and if a financial instrument is treated as a “swap” for purposes

of these rules.

Another commenter agreed with the

embedded loan rule, including use of

the “significant” standard, and also recommended exceptions to the embedded

loan rule for both cleared swaps and noncleared swaps that are required to be fully collateralized by the terms of the swap

contract or by a federal regulator. However, this commenter interpreted the embedded loan rule in the proposed regulations

to apply solely for purposes of section

628

163(j) and recommended that the embedded loan rule, as well as timing and character rules for nonperiodic payments on

swaps, be issued under section 446. Until

that guidance is issued, the commenter

requested that the application of the embedded loan rule for purposes of section

163(j) be delayed. The proposed regulations provide that the time value component of the embedded loan is determined

in accordance with §1.446-3(f)(2)(iii)(A).

This commenter questioned the reference

to §1.446-3(f)(2)(iii)(A) because, under

that rule, the time value component is not

treated as interest; rather, the time value

component is only used to compute the

amortization of the nonperiodic payment.

As a result of the cross-reference in

proposed §1.446-3(g)(4) to proposed

§1.163(j)-1(b)(20)(ii), the embedded

loan rule set forth in the proposed regulations applies for purposes of both sections 163(j) and 446. In addition, and as

noted in the preamble to the proposed

regulations, the embedded loan rule set

forth in the proposed regulations applies

in the same manner that former §1.4463(g)(4) applied before it was amended by

the now expired temporary regulations in

T.D. 9719 (80 FR 26437) (May 8, 2015)

(as corrected by 80 FR 61308 (October

13, 2015)). The Treasury Department and

the IRS do not adopt commenters’ suggestions to delay finalizing the embedded loan rule or to provide guidance on

determining if a nonperiodic payment is

“significant” because the same embedded

loan rule applied in the context of section

446 for over 20 years from 1993 to 2015.

See T.D. 8491 (58 FR 53125) (October

14, 1993). Instead, subject to the exceptions discussed in this part II(E)(2) of this

Summary of Comments and Explanation

of Revisions section, the final regulations

adopt the embedded loan rule without

change. The final regulations retain the

reference to §1.446-3(f)(2)(iii)(A), which

provides a known method for computing

the time value component associated with

the loan component that is treated as interest under §§1.163(j)-1(b)(22)(ii) and

1.446-3(g)(4).

Further, to eliminate the possibility of

confusion regarding the application of the

embedded loan rule for purposes of sections 163(j) and 446, the final regulations

add the substantive text of the embedded

Bulletin No. 2020–40

loan rule and the exceptions to that rule

to both §§1.446-3(g)(4) and 1.163(j)1(b)(22)(ii) instead of merely including

a cross-reference in §1.446-3(g)(4) to

§1.163(j)-1(b)(22)(ii).

In response to comments, the final regulations add two exceptions to the embedded loan rule. Specifically, the final regulations add exceptions for cleared swaps

and for non-cleared swaps that require

the parties to meet the margin or collateral requirements of a federal regulator

or that provide for margin or collateral

requirements that are substantially similar

to a cleared swap or a non-cleared swap

subject to the margin or collateral requirements of a federal regulator. For purposes

of this exception, the term “federal regulator” means the Securities and Exchange

Commission (SEC), the Commodity Futures Trading Commission (CFTC), or a

prudential regulator, as defined in section

1a(39) of the Commodity Exchange Act (7

U.S.C. 1a), as amended by section 721 of

the Dodd-Frank Wall Street Reform and

Consumer Protection Act of 2010, Public

Law No. 111-203, 124 Stat. 1376, Title

VII (the Dodd-Frank Act). Because federal regulators have adopted final requirements for non-cleared swaps that permit

netting of swap exposures and specify the

types of collateral required to be posted,

the final regulations do not address netting

or require that the margin or collateral be

paid or received in cash.

In addition, §1.163(j)-1(c)(3)(i) delays

the applicability date of the embedded

loan rule for purposes of section 163(j)

to allow taxpayers additional time to develop systems to implement these rules

(the delayed applicability date), though

taxpayers may choose to apply the rules

to swaps entered into before the delayed

applicability date. See also §1.446-3(j)

(2), which provides applicability date

rules similar to those in §1.163(j)-1(c)

(3)(i). However, the delayed applicability date does not apply for purposes of

the anti-avoidance rules in §1.163(j)-1(b)

(22)(iv) (described in part II(E)(4) of this

Summary of Comments and Explanation

of Revisions section). Instead, the applicability date in §1.163(j)-1(c)(3)(ii) applies.

As a result, the anti-avoidance rules in

§1.163(j)-1(b)(22)(iv) apply to a notional

principal contract entered into on or after

September 14, 2020. However, for a no-

Bulletin No. 2020–40

tional principal contract entered into before September 14, 2021, the anti-avoidance rules in §1.163(j)-1(b)(22)(iv) apply

without regard to the references in those

rules to §1.163(j)-1(b)(22)(ii). For example, if a taxpayer enters into a swap with a

significant nonperiodic payment that does

not meet the exceptions in §1.163(j)-1(b)

(22)(ii)(B) or (C) before the delayed applicability date, and a principal purpose of

the taxpayer is to reduce the amount that

otherwise would be interest expense, the

anti-avoidance rules apply and the taxpayer must treat the time value component

associated with the loan component of the

swap as interest expense.

3. Other Amounts Treated as Interest

i. Items Relating to Premium, Ordinary

Income or Loss on Certain Debt

Instruments, Section 1258 Gain, and

Factoring Income

Proposed

§1.163(j)-1(b)(20)(iii)(A)

treats any bond issuance premium treated

as ordinary income under §1.163-13(d)

(4) as interest income of the issuer and

any amount deductible as a bond premium deduction under §1.171-2(a)(4)(i)(A)

or (C) as interest expense of the holder.

Proposed §1.163(j)-1(b)(20)(iii)(B) treats

any ordinary income recognized by an issuer of a debt instrument, and any ordinary loss recognized by a holder of a debt

instrument, under the rules for a contingent payment debt instrument, a nonfunctional currency contingent payment debt

instrument, or an inflation-indexed debt

instrument, as interest income of the issuer and as interest expense of the holder,

respectively. Proposed §1.163(j)-1(b)(20)

(iii)(D) treats any ordinary gain under section 1258 as interest income. Commenters

supported treating the amounts in proposed §1.163(j)-1(b)(20)(iii)(A), (B), and

(D) as interest income or interest expense

for purposes of section 163(j). Accordingly, the final regulations adopt the rules in

the proposed regulations for these three

items without any substantive changes.

Proposed

§1.163(j)-1(b)(20)(iii)(J)

treats factoring income as interest income.

Several commenters supported treating factoring income as interest income.

However, one commenter questioned the

differences between the provisions related

629

to the inclusion of factoring income and

§1.954-2(h)(4). The inclusion of factoring

income in the definition of interest is generally supported by the commenters, is a

taxpayer-favorable rule, is generally consistent with the rules in §1.954-2(h)(4),

and is consistent with the treatment of other types of discount, such as acquisition

discount and market discount. Accordingly, the final regulations adopt the rules

in the proposed regulations for factoring

income without any substantive changes.

In the case of a factoring transaction with

a principal purpose of artificially increasing a taxpayer’s business interest income,

the anti-avoidance rules in §1.163(j)-1(b)

(22)(iv) (described in part II(E)(4) of this

Summary of Comments and Explanation

of Revisions section) would not permit the

taxpayer to treat factoring income as interest income for purposes of section 163(j).

ii. Substitute Interest Payments

Proposed

§1.163(j)-1(b)(20)(iii)(C)

generally provides that a substitute interest payment described in §1.861-2(a)(7)

and made in connection with a sale-repurchase or securities lending transaction

is treated as interest expense to the payor and interest income to the recipient.

In general, substitute interest payments

are economically equivalent to interest.

A few commenters questioned the inclusion of substitute interest payments in the

definition of interest in the proposed regulations. Commenters stated that treating

these amounts as interest would be contrary to longstanding tax law, including

the holding in Deputy v. Du Pont, 308

U.S. 488, 498 (1940). However, commenters recommended that, if the Treasury Department and the IRS decide to

include substitute interest payments in the

definition of interest in the final regulations, the inclusion be limited to the extent

the substitute interest payments relate to

transactions that are economically similar

to a borrowing. Commenters recommended that the following factors be taken into

consideration in making this determination: (a) Whether the taxpayer posted (or

has received) collateral consisting of cash

or liquid assets; (b) whether the borrowed

security is due to mature shortly after the

scheduled termination date of the securities borrowing; (c) the type of security

September 28, 2020

being lent (for example, Treasury bonds as

compared to riskier corporate bonds); and

(d) whether the securities borrowing was

entered into in the ordinary course of the

taxpayer’s trade or business.

The final regulations retain substitute

interest payments in the definition of interest because the payments generally are

economically equivalent to interest and

should be treated as such for purposes of

section 163(j). However, in response to

comments, the final regulations provide

that a substitute interest payment is treated as interest expense to the payor only if

the payment relates to a sale-repurchase

or securities lending transaction that is

not entered into by the payor in the payor’s ordinary course of business, and that

a substitute interest payment is treated as

interest income to the recipient only if the

payment relates to a sale-repurchase or securities lending transaction that is not entered into by the recipient in the recipient’s

ordinary course of business. The final regulations do not adopt the other suggested

factors because the Treasury Department

and the IRS have determined that the ordinary course rule in the final regulations

provides an appropriate and effective limit

on the scope of the definition. Specifically, the Treasury Department and the IRS

have determined that these transactions

are rarely entered into outside the payor’s

ordinary course of business, and that any

such non-ordinary course transactions

likely would involve an intention to avoid

section 163(j).

iii. Commitment Fees

Proposed §1.163(j)-1(b)(20)(iii)(G)

(1) treats any fees in respect of a lender commitment to provide financing as

interest if any portion of such financing

is actually provided. Commenters recommended that commitment fees and

other debt-related fees not be included

in the definition of interest until general substantive guidance is provided on

the treatment of the fees in the separate

fee-related project on the Office of Tax

Policy and IRS 2019-2020 Priority Guidance Plan (REG-132517-17). According

to the commenters, uncertainty exists as

to whether to characterize these fees for

Federal income tax purposes as fees for

services or property or for compensation

September 28, 2020

for the use or forbearance of money. In

addition, under existing guidance, commitment fees are treated differently by

the borrower (similar to an option premium) and the lender (service income).

See Rev. Rul. 81-160, 1981-1 C.B. 312,

and Rev. Rul. 70-540, 1970-2 C.B. 101,

Situation (3). Some taxpayers, however,

argue that a commitment fee should be

treated as creating or increasing discount

on a debt instrument and that the fee

should be treated consistently by both the

borrower and the lender. If commitment

fees are included in the definition of interest in the final regulations, commenters recommended that only the portion of

the commitment fee that is proportionate

to the amount drawn be treated as interest.

In response to comments, the final regulations do not include commitment fees

in the definition of interest. The treatment

of commitment fees and other fees paid in

connection with lending transactions will

be addressed in future guidance that applies for all purposes of the Code.

iv. Debt Issuance Costs

Proposed

§1.163(j)-1(b)(20)(iii)(H)

treats debt issuance costs as interest expense of the issuer. Commenters argued

that debt issuance costs should not be

treated as interest expense because these

costs are paid to third parties in connection with the issuance of debt and are not

paid or incurred for the use or forbearance

of money under a debt instrument. For tax

purposes, these costs are capitalized by

the issuer and are treated as deductible under section 162 over the term of the debt

instrument as if the costs adjust the instrument’s yield by reducing the instrument’s

issue price by the amount of the costs. See

§1.446-5.

In response to comments, the final regulations exclude debt issuance costs from

the definition of interest.

v. Guaranteed Payments

Proposed

§1.163(j)-1(b)(20)(iii)(I)

provides that any guaranteed payments for

the use of capital under section 707(c) are

treated as interest. Some commenters stated that a guaranteed payment for the use

of capital should not be treated as interest

630

for purposes of section 163(j) unless the

guaranteed payment was structured with

a principal purpose of circumventing section 163(j). Other commenters stated that

section 163(j) never should apply to guaranteed payments for the use of capital.

In response to comments, the final

regulations do not explicitly include

guaranteed payments for the use of capital under section 707(c) in the definition

of interest. However, consistent with the

recommendations of some commenters,

the anti-avoidance rules in §1.163(j)-1(b)

(22)(iv) (described in part II(E)(4) of this

Summary of Comments and Explanation

of Revisions section) include an example

of a situation in which a guaranteed payment for the use of capital is treated as

interest expense and interest income for

purposes of section 163(j). See §1.163(j)1(b)(22)(v)(E), Example 5.

vi. Hedging Transactions

Proposed

§1.163(j)-1(b)(20)(iii)(E)

generally treats income, deduction, gain,

or loss from a derivative that alters a taxpayer’s effective cost of borrowing with

respect to a liability of the taxpayer as an

adjustment to the taxpayer’s interest expense. Proposed §1.163(j)-1(b)(20)(iii)

(F) generally treats income, deduction,

gain, or loss from a derivative that alters

a taxpayer’s effective yield with respect to

a debt instrument held by the taxpayer as

an adjustment to the taxpayer’s interest income. The rules in the two provisions are

referred to as the “hedging rules” in this

preamble.

Numerous comments were received on

the hedging rules. The commenters questioned the administrability of the broad

hedging rules, especially if the taxpayer

hedges on a macro (that is, on an aggregate) basis. Also, the commenters noted

that it is not clear how to apply the rules in

certain situations, including a situation in

which the hedge relates to non-debt items

(for example, if the taxpayer hedges the

mismatch or “gap” between its assets and

liabilities), the debt instrument is not subject to section 163(j), or the debt instrument is subject to other interest deferral

provisions for Federal tax purposes. In

addition, the commenters noted that the

proposed regulations effectively would

require integration, even if the hedge oth-

Bulletin No. 2020–40

erwise would not be integrated with the

debt instrument for Federal tax purposes and the income, deduction, gain, and

loss from the hedge ordinarily would be

accounted for separately, which the commenters suggested would require taxpayers to maintain two sets of books. Moreover, the commenters stated that, under

the proposed regulations, any gain or loss

on the underlying debt instrument (for

example, due to changes in interest rates)

would not be treated as an adjustment to

interest income or expense, whereas the

corresponding loss or gain on the hedge

would be treated as an adjustment to interest expense or income. Some commenters

stated that the yield on third-party borrowings reflects the true cost of the borrowing, and that hedges are not relevant to the

cost of the borrowing.

Commenters recommended that, if the

hedging rules are retained in the final regulations as a separate item, the final regulations precisely define (a) what standard

is used to include a derivative in section

163(j) (for example, a primary purpose

or principal motivation standard), and

(b) the standard for determining whether

the effect of a derivative on the cost of

borrowing or effective yield is sufficiently significant for the income, deduction,

gain, or loss from the derivative to be included in the computation. Commenters

noted that one approach would be to apply the hedging rules only to derivatives

that qualify for integration under §1.9885 or §1.1275-6. Another approach would

be to apply the hedging rules to derivatives that have a sufficiently close connection with the liability to qualify as

hedging transactions under §§1.446-4

and 1.1221-2. Some commenters indicated that the hedging rules could apply

if the derivative is treated as a hedge of

a borrowing or liability for financial reporting purposes, and that the hedging

rules should not apply to broker-dealers,

active traders in derivatives, and financial institutions acting in the ordinary

course of business.

One commenter recommended that

section 163(j) not alter the timing of taxable items from hedging transactions that

are subject to §1.446-4, regardless of

whether interest expense on the hedged

item is deferred under section 163(j). Other commenters noted that the proposed

Bulletin No. 2020–40

regulations do not provide guidance on

the interaction between the hedging rules

and the straddle rules.

With respect to foreign currency hedging transactions, a commenter noted that

foreign currency gain or loss is due to the

time value of money only to a limited extent; thus, the commenter recommended

that section 163(j) not apply to a taxpayer’s foreign currency hedging transactions

(other than an integrable transaction under

§1.988-5).

In response to comments, the final regulations do not include the hedging rules

in the definition of interest. However, in

certain circumstances, the anti-avoidance

rules in §1.163(j)-1(b)(22)(iv) (described

in part II(E)(4) of this Summary of Comments and Explanation of Revisions

section) may apply to require income,

deduction, gain, or loss from a hedging

transaction to be taken into account for

purposes of section 163(j).

vii. Other Items

Commenters recommended other items

to be included in, or excluded from, the

definition of interest as follows:

a. Dividends from Regulated Investment

Company (RIC) Shares

Some commenters recommended that

dividend income from a RIC be treated

as interest income for a shareholder in a

RIC, to the extent that the dividend is attributable to interest income earned by the

RIC. To address this comment, in the Concurrent NPRM, the Treasury Department

and the IRS have proposed rules under

which a RIC that earns business interest

income may pay section 163(j) interest

dividends that certain shareholders may

treat as interest income for purposes of

section 163(j). See paragraphs (b)(22)(iii)

(F) and (b)(35) in proposed §1.163(j)-1 in

the Concurrent NPRM.

b. MMF Income

A few commenters recommended that

the final regulations allow look-through

treatment for earnings from certain foreign entities, such as foreign money

market funds (MMFs), so that dividends

from foreign MMFs would be treated as

631

interest income to the extent the underlying income derived by a foreign MMF

was interest income. According to the

commenters, this treatment would alleviate issues for a CFC that borrows money

from related parties and invests in foreign MMFs. In general, the commenters

stated that any interest limitation under

section 163(j) could lead to unexpected

results in this situation, such as section

952(c) recapture accounts solely generated by the section 163(j) interest expense

limitation.

The final regulations do not adopt this

recommendation because it is beyond the

scope of the final regulations and because

there are significant differences between

the rules governing income inclusions

in respect of passive foreign investment

companies (PFICs), such as foreign

MMFs, and RICs. These differences make

it difficult to adopt a rule that would provide for look-through treatment in the

context of dividends or inclusions from

a PFIC. In particular, the regime for taxing income from a PFIC that shareholders

have elected to treat as a qualified electing

fund (QEF) under section 1295 generally

focuses only on inclusions related to ordinary income or net capital gain income

and does not separately report amounts

of interest income for Federal income tax

purposes. In the case of a PFIC for which

a QEF election has not been made, there

would be no information about the underlying taxable income of the PFIC and

no reason or ability to treat an interest in

the PFIC differently from the treatment of

stock held in other C corporations.

c. Negative Interest

One commenter requested clarification

on the treatment of negative interest (an

amount that a depositor may owe a bank

in a negative interest rate environment)

and inquired whether such payments are

more similar to payments for custodial or

service fees rather than for interest. The

final regulations do not address this issue

because it is beyond the scope of the final

regulations. However, in certain cases (for

example, a Treasury bill acquired with a

negative yield), a payment may be treated

as bond premium subject to the rules in

section 171, including the rules in §1.1712(a)(4)(i)(C).

September 28, 2020

d. Leases

A commenter recommended that the

Treasury Department and the IRS adopt

rules that clearly describe the circumstances

in which fleet leases are treated as generating

interest for purposes of section 163(j). The

commenter noted that there is a time-valueof-money portion of a fleet lease payment

similar to the time-value-of-money portion

of other items treated as interest under the

proposed regulations, such as guaranteed

payments, commitment fees, debt issuance

costs, and items of income or loss from a

derivative instrument that alters a taxpayer’s

effective yield or effective cost of borrowing. In addition, to the extent that the anti-avoidance rule in the proposed regulations

is retained, the commenter asked that the

final regulations clearly define the circumstances (if any) in which the anti-avoidance

rule would operate to recharacterize any

portion of a fleet lease payment as interest

expense, and modify the anti-avoidance rule

to apply to both interest expense of the fleet

lessee and interest income of the fleet lessor.

The Treasury Department and the IRS

do not adopt the commenter’s suggestions

in the final regulations because the suggestions generally are no longer relevant after

the revisions made to the definition of interest in the final regulations. For example, as

explained in this part II(E)(3) of this Summary of Comments and Explanation of Revisions section, no portion of the items generally cited by the commenter is explicitly

treated as interest in the final regulations.

Moreover, there are explicit provisions in

the Code that determine whether a portion

of a lease payment is treated as interest for

Federal income tax purposes depending on

the terms of a lease, such as sections 467

and 483. In addition, as explained in part

II(E)(4) of this Summary of Comments and

Explanation of Revisions section, the anti-avoidance rule in the final regulations is

revised to include a principal purpose test

and to generally align the treatment of income and expense, which should address

the commenter’s concerns.

4. Anti-Avoidance Rule for Amounts

Predominantly Associated with the Time

Value of Money

Proposed §1.163(j)-1(b)(20)(iv) provides that any expense or loss, to the ex-

September 28, 2020

tent deductible, incurred by a taxpayer

in a transaction or series of integrated or

related transactions in which the taxpayer secures the use of funds for a period of

time is treated as interest expense of the

taxpayer if such expense or loss is predominantly incurred in consideration of

the time value of money. Numerous comments were received on this anti-avoidance rule in the proposed regulations.

Most commenters recommended that any

anti-avoidance rule in the final regulations

contain a requirement that the taxpayer

have a principal purpose to avoid section

163(j). Several commenters asserted that

the anti-avoidance rule should cover only

transactions that are economically equivalent to interest and should set forth examples of transactions that are and are not

covered. Most commenters recommended

that the anti-avoidance rule be symmetrical

and apply to income or gain, as well as to

expense or loss. One commenter suggested that, based on section 1258 concepts,

the anti-avoidance rule should apply only

if, at the time of the relevant transaction or

series of transactions that secure the use of

funds for a period of time for the taxpayer, substantially all of the expense or loss

was expected to be attributable to the time

value of money. In addition, commenters

noted that it should be clear when a taxpayer should test whether a transaction

falls within the anti-avoidance rule. Other

commenters requested specific rules coordinating this anti-avoidance rule with the

general anti-avoidance rule in proposed

§1.163(j)-2(h).

Some commenters stated that an interest anti-avoidance rule should not be

included in the final regulations because,

for example, the rule would impose substantial compliance costs, the Treasury

Department and the IRS have other tools

to combat any abuse, and there already is

a general anti-avoidance rule in proposed

§1.163(j)-2(h). Commenters also noted

that the interest anti-avoidance rule in the

proposed regulations has the potential to

capture ordinary market transactions that

possess a time value component but that

are not generally treated as financings

with disguised interest for tax purposes.

In response to comments, the Treasury

Department and the IRS have modified

the anti-avoidance rule in the final regulations. Under §1.163(j)-1(b)(22)(iv)(A)

632

(1), any expense or loss economically

equivalent to interest is treated as interest

expense for purposes of section 163(j) if a

principal purpose of structuring the transaction(s) is to reduce an amount incurred

by the taxpayer that otherwise would have

been interest expense or treated as interest expense under §1.163(j)-1(b)(22)(i)

through (iii). For this purpose, the fact that

the taxpayer has a business purpose for

obtaining the use of funds does not affect

the determination of whether the manner

in which the taxpayer structures the transaction(s) is with a principal purpose of reducing the taxpayer’s interest expense. In

addition, the fact that the taxpayer has obtained funds at a lower pre-tax cost based

on the structure of the transaction(s) does

not affect the determination of whether the

manner in which the taxpayer structures

the transaction(s) is with a principal purpose of reducing the taxpayer’s interest

expense.

For purposes of §1.163(j)-1(b)(22)(iv)

(A)(1), any expense or loss is economically equivalent to interest to the extent that

the expense or loss is (1) deductible by the

taxpayer; (2) incurred by the taxpayer in a

transaction or series of integrated or related transactions in which the taxpayer secures the use of funds for a period of time;

(3) substantially incurred in consideration

of the time value of money; and (4) not

described in §1.163(j)-1(b)(22)(i), (ii), or

(iii).

Under §1.163(j)-1(b)(22)(iv)(A)(2), if

a taxpayer knows that an expense or loss

is treated by the payor as interest expense

under §1.163(j)-1(b)(22)(iv)(A)(1), the

taxpayer provides the use of funds for a

period of time in the transaction(s) subject

to §1.163(j)-1(b)(22)(iv)(A)(1), the taxpayer earns income or gain with respect

to the transaction(s), and such income or

gain is substantially earned in consideration of the time value of money provided

by the taxpayer, such income or gain is

treated as interest income for purposes of

section 163(j) to the extent of the expense

or loss treated by the payor as interest expense under §1.163(j)-1(b)(22)(iv)(A)(1).

Under

§1.163(j)-1(b)(22)(iv)(B),

notwithstanding

§1.163(j)-1(b)(22)(i)

through (iii), any income realized by a

taxpayer in a transaction or series of integrated or related transactions is not treated

as interest income of the taxpayer for pur-

Bulletin No. 2020–40

poses of section 163(j) if and to the extent

that a principal purpose for structuring the

transaction(s) is to artificially increase the

taxpayer’s business interest income. For

this purpose, the fact that the taxpayer

has a business purpose for holding interest-generating assets does not affect the

determination of whether the manner in

which the taxpayer structures the transaction(s) is with a principal purpose of artificially increasing the taxpayer’s business

interest income.

For purposes of the foregoing anti-avoidance rules, §1.163(j)-1(b)(22)(iv)

(C) provides that whether a transaction or a

series of integrated or related transactions

is entered into with a principal purpose depends on all the facts and circumstances

related to the transaction(s), except that the

fact that the taxpayer has obtained funds at

a lower pre-tax cost based on the structure

of the transaction(s) or the fact that the

taxpayer has a business purpose related

to the item is ignored for this purpose. A

purpose may be a principal purpose even

though it is outweighed by other purposes

taken together or separately. Factors to be

taken into account in determining whether one of the taxpayer’s principal purposes for entering into the transaction(s)

include the taxpayer’s normal borrowing

rate in the taxpayer’s functional currency,

whether the taxpayer would enter into the

transaction(s) in the ordinary course of

the taxpayer’s trade or business, whether

the parties to the transaction(s) are related persons (within the meaning of section

267(b) or section 707(b)), whether there is

a significant and bona fide business purpose for the structure of the transaction(s),

whether the transactions are transitory, for

example, due to a circular flow of cash or

other property, and the substance of the

transaction(s).

In response to comments, §1.163(j)1(b)(22)(iv)(D) provides that the anti-avoidance rules in §1.163(j)-1(b)(22)

(iv), rather than the general anti-avoidance

rules in §1.163(j)-2(j), apply to determine

whether an item is treated as interest expense or interest income.

Section 1.163(j)-1(b)(22)(v) contains

examples illustrating the application of the

interest anti-avoidance rules in a number

of situations, including examples relating

to a hedging transaction involving a foreign currency swap transaction, a forward

Bulletin No. 2020–40

contract involving gold, a loan guaranteed

by a related party in which the related party receives guarantee fees, and guaranteed

payments for the use of capital. However,

these examples are not intended to represent the only situations in which the anti-avoidance rules might apply.

The anti-avoidance rules in §1.163(j)1(b)(22)(iv) apply to transactions entered

into on or after September 14, 2020. See

§1.163(j)-1(c)(2).

5. Authority Comments

Most of the commenters on the definition of interest in the proposed regulations

questioned whether the Treasury Department and the IRS have the authority to

expand the definition of interest for purposes of section 163(j) to include “interest

equivalents” (the items listed in proposed

§1.163(j)-1(b)(20)(iii) and the expenses

or losses subject to the anti-avoidance rule

in proposed §1.163(j)-1(b)(20)(iv)). The

commenters asserted that the term “business interest” in section 163(j)(5) means

any interest paid or accrued on indebtedness properly allocable to a trade or business, and that expanding the definition to

include interest equivalents would capture

amounts that do not fall within the scope

of the general rule in section 163(a) that

“[t]here shall be allowed as a deduction

all interest paid or accrued within the taxable year on indebtedness.” Even though

section 163(j)(1) refers to an “amount allowed as a deduction under this chapter

for business interest” when describing

the amounts limited by section 163(j),

the commenters argued that the deduction

otherwise allowed must be with respect

to “business interest” (which is defined in

section 163(j)(5)) and that the phrase “deduction under this chapter” does not and

should not modify the definition of “business interest” in section 163(j)(5).

The commenters noted that section

163(j), as amended by the TCJA, does not

contain a specific delegation of regulatory

authority to expand the definition of interest. The commenters further asserted that

the Treasury Department and the IRS may

issue only “interpretive regulations” under

section 7805, and that any such regulations

may not go beyond the stated meaning of

the statutory language. The commenters

noted that old section 163(j)(9) provided

633

broad regulatory authority to prescribe

regulations, including regulations appropriate to prevent the avoidance of old section 163(j). In addition, the commenters

noted that the legislative history for old

section 163(j) indicated that the Treasury

Department could issue guidance treating

“items not denominated as interest but

appropriately characterized as equivalent

to interest” as interest income or interest

expense. The commenters stated that there

is no similar regulatory authority or legislative history relating to section 163(j) as

amended by the TCJA.

Commenters also noted that, when

Congress has chosen to expand the definition of interest in other parts of the Code,

Congress has done so explicitly. For example, section 263(g) provides that, “[for

purposes of section 263(g)(2)(A)], the

term ‘interest’ includes any amount paid

or incurred in connection with personal

property used in a short sale.” As noted in

the preamble to the proposed regulations,

most of the rules treating interest equivalent items as interest income or expense

in proposed §1.163(j)-1(b)(20)(iii) were

developed in §§1.861-9T and 1.954-2.

However, commenters argued that the use

of the interest equivalent provisions in

§§1.861-9T and 1.954-2 by analogy to define interest for purposes of section 163(j)

is inappropriate because different policy

considerations underlie those sections,

there is statutory or regulatory authority

to address interest equivalents under those

sections (unlike section 163(j)), and those

sections apply only for limited purposes

(for example, for sourcing purposes).

In addition, because the broad definition of interest in the proposed regulations

applies only for purposes of section 163(j),

commenters asserted that there will be

additional compliance burdens and costs

for taxpayers to separately track amounts

treated as interest for purposes of section

163(j) and for other purposes. Commenters asserted that the broad definition of

interest for purposes of section 163(j) in

the proposed regulations may create uncertainty and confusion for taxpayers with

respect to other sections of the Code.

Contrary to the assertions made by

many of the commenters, the Treasury

Department and the IRS have the authority to prescribe rules relating to interest

equivalents and an anti-avoidance rule.

September 28, 2020

As noted in the preamble to the proposed

regulations, there are no generally applicable regulations or statutory provisions

addressing when financial instruments are

treated as indebtedness for Federal income

tax purposes or when a payment is “interest.” Therefore, a regulatory definition of

interest is needed in order to implement

the statutory language of section 163(j).

In addition, it would be inconsistent

with the purpose of section 163(j) to allow

transactions that are essentially financing transactions to avoid the application

of section 163(j). Thus, an anti-avoidance rule is needed to address situations

in which a taxpayer’s principal purpose

in structuring a transaction or series of

transactions is to artificially reduce the

taxpayer’s business interest expense or to

increase the taxpayer’s business interest

income. Moreover, at least one commenter suggested the inclusion of the type of

anti-avoidance rule that is included in the

final regulations and that the Treasury Department and the IRS have the authority to

include such a rule.

Section 7805(a) provides the Treasury

Department and the IRS with the authority

to prescribe all rules and regulations needed for enforcement of the Code, including

all rules and regulations as may be necessary by reason of any alteration of law

in relation to internal revenue. Providing a

regulatory definition of interest for purposes of section 163(j) and the anti-avoidance

rule falls within this authority. The statutory language of section 163(j)(1) (‘‘The

amount allowed as a deduction under this

chapter for any

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