Sec. 1.951A-4 Tested interest expense and tested interest income.
(a) Scope. This section provides rules for determining the tested interest expense and tested interest income of a controlled foreign corporation for purposes of determining a United States shareholder’s specified interest expense under §1.951A-1(c)(3)(iii). Paragraph (b) of this section provides definitions related to tested interest expense and tested interest income. Paragraph (c) of this section provides examples illustrating these definitions and the application of §1.951A-1(c)(3)(iii). The amount of specified interest expense determined under §1.951A-1(c)(3)(iii) and this section is the amount of interest expense described in section 951A(b)(2)(B).
(b) Definitions related to specified interest expense.
(1) Tested interest expense.
(i) In general. The term tested interest expense means, with respect to a controlled foreign corporation for a CFC inclusion year, interest expense paid or accrued by the controlled foreign corporation that is allocated and apportioned to gross tested income of the controlled foreign corporation for the CFC inclusion year under §1.951A-2(c)(3), reduced (but not below zero) by the sum of the qualified interest expense of the controlled foreign corporation for the CFC inclusion year and the tested loss QBAI amount of the controlled foreign corporation for the CFC inclusion year.
(ii) Interest expense. The term interest expense means any expense or loss that is treated as interest expense under section 163(j).
(iii) Qualified interest expense.
(A) In general. The term qualified interest expense means, with respect to a controlled foreign corporation for a CFC inclusion year, to the extent established by the controlled foreign corporation, the interest expense paid or accrued by the controlled foreign corporation that is allocated and apportioned to gross tested income of the controlled foreign corporation for the CFC inclusion year under §1.951A-2(c)(3), multiplied by a fraction, the numerator of which is the average of the aggregate adjusted bases as of the close of each quarter of the CFC inclusion year of qualified assets held by the controlled foreign corporation, and the denominator of which is the average of the aggregate adjusted bases as of the close of each quarter of the CFC inclusion year of all assets held by the controlled foreign corporation.
(B) Qualified asset.
(1) In general. Except as provided in paragraph (b)(1)(iii)(B)(2) of this section, the term qualified asset means, with respect to a controlled foreign corporation for a CFC inclusion year, any obligation or financial instrument held by the controlled foreign corporation that gives rise to income included in the gross tested income of the controlled foreign corporation for the CFC inclusion year that is excluded from foreign personal holding company income (as defined in section 954(c)(1)) by reason of section 954(c)(2)(C)(ii) or section 954(h) or (i).
(2) Exclusion for related party receivables. A qualified asset does not include an asset that gives rise to interest income that is also excludible from foreign personal holding company income by reason of section 954(c)(3) or (6).
(3) Look-through rule for subsidiary stock. For purposes of paragraph (b)(1)(iii)(A) of this section, the adjusted basis in the stock of another controlled foreign corporation held by a controlled foreign corporation is treated as adjusted basis in a qualified asset in an amount equal to the adjusted basis in the stock multiplied by the fraction described in paragraph (b)(1)(iii)(A) of this section determined with respect to the assets of such other controlled foreign corporation.
(4) Look-through rule for certain partnership interests. For purposes of paragraph (b)(1)(iii)(A) of this section, if a controlled foreign corporation owns 25 percent or more of the capital or profits interest in a partnership the controlled foreign corporation is treated as holding its attributable share of any property held by the partnership, as determined under the principles of §1.956-4(b), and the controlled foreign corporation’s basis in the partnership interest is not taken into account.
(iv) Tested loss QBAI amount. The term tested loss QBAI amount means, with respect to a tested loss CFC for a CFC inclusion year, 10 percent of the amount that would be the qualified business asset investment of the tested loss CFC for the CFC inclusion year under section 951A(d) and §1.951A-3 if the tested loss CFC were a tested income CFC for the CFC inclusion year.
(2) Tested interest income.
(i) In general. The term tested interest income means, with respect to a controlled foreign corporation for a CFC inclusion year, interest income included in gross tested income of the controlled foreign corporation for the CFC inclusion year, reduced by qualified interest income of the controlled foreign corporation for the CFC inclusion year.
(ii) Interest income. The term interest income means any income or gain that is treated as interest income under section 163(j).
(iii) Qualified interest income.
(A) In general. Except as provided in paragraph (b)(2)(iii)(B) of this section, the term qualified interest income means, with respect to a controlled foreign corporation for a CFC inclusion year, interest income of the controlled foreign corporation for the CFC inclusion year included in the gross tested income of the controlled foreign corporation for the CFC inclusion year that is excluded from foreign personal holding company income (as defined in section 954(c)(1)) by reason of section 954(c)(2)(C)(ii) or section 954(h) or (i).
(B) Exclusion for related party interest. Qualified interest income does not include interest income that is also excludible from foreign personal holding company income by reason of section 954(c)(3) or (6).
(c) Examples. The following examples illustrate the application of this section.
(1) Example 1: Wholly-owned CFCs.
(i) Facts. A Corp, a domestic corporation, owns 100% of the single class of stock of each of FS1 and FS2, each a controlled foreign corporation. A Corp, FS1, and FS2 all use the calendar year as their taxable year. For Year 1, FS1 and FS2 are both tested income CFCs. In Year 1, FS1 pays $100x of interest to FS2. The interest expense of FS1 is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). The interest income of FS2 is excluded from its foreign personal holding company income under section 954(c)(6). Also, in Year 1, FS2 pays $100x of interest to a bank that is not related to FS2, which interest expense is allocated and apportioned to FS2’s gross tested income under §1.951A-2(c)(3). Neither FS1 nor FS2 holds qualified assets or owns stock of another controlled foreign corporation.
(ii) Analysis.
(A) CFC-level determination; tested interest expense and tested interest income.
(1) Tested interest expense and tested interest income of FS1. FS1 has $100x of interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). FS1 has no interest income. Accordingly, FS1 has $100x of tested interest expense and no tested interest income for Year 1.
(2) Tested interest expense and tested interest income of FS2. FS2 has $100x of interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3) and $100x of interest income that is included in its gross tested income. Accordingly, FS2 has $100x of tested interest expense and $100x of tested interest income for Year 1.
(B) United States shareholder-level determination; pro rata share and specified interest expense. Under §1.951A-1(d)(5) and (6), A Corp’s pro rata share of FS1’s tested interest expense is $100x, its pro rata share of FS2’s tested interest expense is $100x, and its pro rata share of FS2’s tested interest income is $100x. For Year 1, A Corp’s aggregate pro rata share of tested interest expense is $200x and its aggregate pro rata share of tested interest income is $100x. Accordingly, under §1.951A-1(c)(3)(iii), A Corp’s specified interest expense is $100x ($200x - $100x) for Year 1.
(2) Example 2: Less than wholly-owned CFCs.
(i) Facts. The facts are the same as in paragraph (c)(1)(i) of this section (the facts in Example 1), except that A Corp owns 50% of the single class of stock of FS1 and 80% of the single class of stock of FS2.
(ii) Analysis.
(A) CFC-level determination; tested interest expense and tested interest income. The analysis is the same as in paragraph (c)(1)(ii)(A) of this section (paragraph (A) of the analysis in Example 1).
(B) United States shareholder-level determination; pro rata share and specified interest expense. Under §1.951A-1(d)(5) and (6), A Corp’s pro rata share of FS1’s tested interest expense is $50x ($100x x 0.50), its pro rata share of FS2’s tested interest expense is $80x ($100x x 0.80), and its pro rata share of FS2’s tested interest income is $80x ($100x x 0.80). For Year 1, A Corp’s aggregate pro rata share of the tested interest expense is $130x ($50x + $80x) and its aggregate pro rata share of the tested interest income is $80x ($0 + $80x). Accordingly, under §1.951A-1(c)(3)(iii), A Corp’s specified interest expense is $50x ($130x - $80x) for Year 1.
(3) Example 3: Operating company; qualified interest expense.
(i) Facts. B Corp, a domestic corporation, owns 100% of the single class of stock of each of FS1 and FS2, each a controlled foreign corporation. For Year 1, FS1 and FS2 are both tested income CFCs. B Corp, FS1, and FS2 all use the calendar year as their taxable year. FS2 is an eligible controlled foreign corporation within the meaning of section 954(h)(2). In Year 1, FS1 pays $100x of interest to FS2. The interest expense of FS1 is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). The interest income of FS2 is excluded from its foreign personal holding company income by reason of section 954(c)(6). In addition, in Year 1, FS2 receives $300x of interest from customers that are not related to FS2, which interest income is excluded from FS2’s foreign personal holding company income by reason of section 954(h), and FS2 pays $300x of interest to a bank, which interest expense is allocated and apportioned to FS2’s gross tested income under §1.951A-2(c)(3). Neither FS1 nor FS2 owns stock of another controlled foreign corporation. FS1 does not hold qualified assets. FS2’s average adjusted bases in qualified assets is $8,000x, and FS2’s average adjusted bases in all its assets is $12,000x.
(ii) Analysis.
(A) CFC-level determination; tested interest expense and tested interest income.
(1) Tested interest expense and tested interest income of FS1. FS1 has $100x of interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). FS1 has no interest income. Accordingly, FS1 has $100x of tested interest expense and no tested interest income for Year 1.
(2) Tested interest expense and tested interest income of FS2. FS2 has $300x of interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3) and $400x of interest income that is included in gross tested income. However, a portion of FS2’s interest income is excluded from foreign personal holding company income by reason of section 954(h), and a portion of FS2’s assets are qualified assets. As a result, in determining the tested interest income and tested interest expense of FS2, the qualified interest income and qualified interest expense of FS2 are excluded. FS2 has qualified interest income of $300x, the amount of FS2’s interest income that is excluded from foreign personal holding company income by reason of section 954(h). In addition, FS2 has qualified interest expense of $200x, the amount of FS2’s interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3) ($300x), multiplied by a fraction, the numerator of which is FS2’s average adjusted bases in qualified assets ($8,000x), and the denominator of which is FS2’s average adjusted bases in all its assets ($12,000x). Accordingly, FS2 has tested interest income of $100x ($400x - $300x) and tested interest expense of $100x ($300x - $200x) for Year 1.
(B) United States shareholder-level determination; pro rata share and specified interest expense. Under §1.951A-1(d)(5) and (6), B Corp’s pro rata share of FS1’s tested interest expense is $100x, its pro rata share of FS2’s tested interest expense is $100x, and its pro rata share of FS2’s tested interest income is $100x. For Year 1, B Corp’s aggregate pro rata share of tested interest expense is $200x ($100x + $100x) and its aggregate pro rata share of tested interest income is $100x ($0 + $100x). Accordingly, under §1.951A-1(c)(3)(iii), B Corp’s specified interest expense is $100x ($200x - $100x) for Year 1.
(4) Example 4: Holding company; qualified interest expense.
(i) Facts. C Corp, a domestic corporation, owns 100% of the single class of stock of each of FS1 and FS2, each a controlled foreign corporation. FS2 owns 100% of the single class of stock of FS3, a qualifying insurance company within the meaning of section 953(e)(3). For Year 1, FS1, FS2, and FS3 are all tested income CFCs. C Corp, FS1, FS2, and FS3 all use the calendar year as their taxable year. In Year 1, FS1 pays $100x of interest to FS3. The interest expense of FS1 is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). The interest income of FS3 is excluded from its foreign personal holding company income by reason of section 954(c)(6). In addition, FS3 receives $300x of interest from persons that are not related to FS3, which interest income is excluded from FS’s foreign personal holding company income by reason of section 954(i). Also in Year 1, FS2 pays $300x of interest to a bank, which interest expense is allocated and apportioned to FS2’s gross tested income under §1.951A-2(c)(3). None of FS1, FS2, or FS3 owns stock of another controlled foreign corporation, except for the stock of FS3 owned by FS2. FS2 has no assets other than the stock of FS3. Neither FS1 nor FS2 hold qualified assets directly. FS2’s average adjusted bases in the FS3 stock is $6,000x. FS3’s average adjusted bases in qualified assets is $8,000x, and FS3’s average adjusted bases in all its assets is $12,000x.
(ii) Analysis.
(A) CFC-level determination; tested interest expense and tested interest income.
(1) Tested interest expense and tested interest income of FS1. In Year 1, FS1 has $100x of interest expense allocated and apportioned to its gross tested income under §1.951A-2(c)(3). FS1 has no interest income. Accordingly, FS1 has $100x of tested interest expense and no tested interest income for Year 1.
(2) Tested interest expense and tested interest income of FS2. FS2 has $300x of interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). FS2 has no interest income. While FS2 holds no qualified assets directly, $4,000x of FS3’s average adjusted basis in FS3 stock is treated as adjusted basis in a qualified asset, which is equal to FS3’s average adjusted basis in FS3 stock ($6,000x) multiplied by a fraction, the numerator of which is FS3’s average adjusted bases in qualified assets ($8,000x), and the denominator of which is FS3’s average adjusted bases in all its assets ($12,000x). Accordingly, FS2 has qualified interest expense of $200x, the amount of FS2’s interest expense allocated and apportioned to FS2’s gross tested income under §1.951A-2(c)(3) ($300x), multiplied by a fraction, the numerator of which is FS2’s average adjusted bases in qualified assets ($4,000x), and the denominator of which is FS2’s average adjusted bases in all its assets ($6,000x). Therefore, FS2 has tested interest expense of $100x ($300x - $200x) and no tested interest income for Year 1.
(3) Tested interest expense and tested interest income of FS3. In Year 1, FS3 has no interest expense, but FS3 has $400x of interest income that is included in gross tested income. However, a portion of FS3’s interest income is excluded from foreign personal holding company income by reason of section 954(i). As a result, in determining the tested interest income of FS3, the qualified interest income of FS3 is excluded. FS3 has qualified interest income of $300x, the amount of FS3’s interest income that is excluded from foreign personal holding company income by reason of section 954(i). Therefore, FS2 has tested interest income of $100x ($400x - $300x) and no tested interest expense for Year 1.
(B) United States shareholder-level determination; pro rata share and specified interest expense. Under §1.951A-1(d)(5) and (6), C Corp’s pro rata share of FS1’s tested interest expense is $100x, its pro rata share of FS2’s tested interest expense is $100x, and its pro rata share of FS3’s tested interest income is $100x. For Year 1, C Corp’s aggregate pro rata share of tested interest expense is $200x ($100x + $100x + $0) and its aggregate pro rata share of tested interest income is $100x ($0 + $0 + $100x). Accordingly, under §1.951A-1(c)(3)(iii), C Corp’s specified interest expense is $100x ($200x - $100x) for Year 1.
(5) Example 5: Specified interest expense and tested loss QBAI amount.
(i) Facts. D Corp, a domestic corporation, owns 100% of a single class of stock of each of FS1 and FS2, each a controlled foreign corporation. For Year 1, FS1 is a tested income CFC and FS2 is a tested loss CFC. D Corp, FS1, and FS2 all use the calendar year as their taxable year. In Year 1, FS1 pays $100x of interest to FS2. The interest expense of FS1 is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). The interest income of FS2 is excluded from its foreign personal holding company income by reason of section 954(c)(6). Also, in Year 1, FS2 pays $100x of interest to a bank that is not related to FS2, which interest expense is allocated and apportioned to FS2’s gross tested income under §1.951A-2(c)(3). Neither FS1 nor FS2 holds qualified assets or owns stock of another controlled foreign corporation. Because FS2 is a tested loss CFC, FS2 has no QBAI. See §1.951A-3(b). However, if FS2 were a tested income CFC, FS2 would have QBAI of $1,000x.
(ii) Analysis.
(A) CFC-level determination; tested interest expense and tested interest income.
(1) Tested interest expense and tested interest income of FS1. In Year 1, FS1 has $100x of interest expense that is allocated and apportioned to its gross tested income under §1.951A-2(c)(3). FS1 has no interest income. Accordingly, FS1 has $100x of tested interest expense and no tested interest income for Year 1.
(2) Tested interest expense and tested interest income of FS2. FS2 has $100x of interest income that is included in gross tested income. Accordingly, FS2 has $100x of tested interest income. FS2 also has 100x of interest expense that is allocated and apportioned to its gross tested income. However, because FS2 is a tested loss CFC, FS2’s tested interest expense is reduced by its tested loss QBAI amount. FS2’s tested loss QBAI amount is $100x (10% of $1,000x, the amount that would be QBAI if FS2 were a tested income CFC). Accordingly, FS2’s tested interest expense is $0 ($100x interest expense - $100x tested loss QBAI amount) for Year 1.
(B) United States shareholder-level determination; pro rata share and specified interest expense. Under §1.951A-1(d)(5) and (6), D Corp’s pro rata share of FS1’s tested interest expense is $100x, its pro rata share of FS2’s tested interest expense is $0, and its pro rata share of FS2’s tested interest income is $100x. For Year 1, D Corp’s aggregate pro rata share of tested interest expense is $100x, and its aggregate pro rata share of tested interest income is $100x. Accordingly, under §1.951A-1(c)(3)(iii), D Corp’s specified interest expense is $0 ($100x - $100x) for Year 1.
[Added by T.D. 9866, 84 FR 29288-29370, June 21, 2019.]
