Page 307 - TaxAdviser_2022

n the law known as the Tax Cuts for many of the companies operating in
There are a few
1
Iand Jobs Act (TCJA), enacted in industries affected by this provision. One
2017, Sec. 163(j) was significantly situations where a potential financial statement impact of
amended by placing limits on the this limitation is a write-down of deferred
tax assets.
deductibility of business interest for company can easily For instance, in its 2017 10-K, Ho-
separate out the
all taxpayers except certain exempt rizon Pharma PLC showed a year-end
financing component
2
trades or businesses. The businesses debt-to-equity ratio of 3:2 and disclosed
of the transaction.
most affected by the new limitation on that the new interest deductibility rules
deducting interest were highly lever- resulted in a write-down of its deferred
tax assets of $59.2 million, accounting
aged entities and those with low profit
1. Business interest income; for 0.6% of 2017 revenues and translat-
margins. Companies that in previous
2. 30% of the adjusted taxable income ing into a loss of $0.36 per share. While
years have narrowly avoided this (50% for 2019 and 2020, per the this was a one-time write-down of
3
interest deductibility limitation should CARES Act); and assets, companies with significant debt
be aware that the limitation is more 3. Floor plan financing interest — spe- financing, such as Horizon Pharma
cific financing related to the acquisi- PLC, cannot easily change their capital
restrictive for tax years starting after
tion of inventory. structure or operating environment, so
2021. As suggested below, one way to
Recently the limitation became they may be struggling with this limita-
help reduce the negative impacts of
even more restrictive. The calculation tion on deductibility of interest for years
Sec. 163(j) is through strategic adop- for adjusted taxable income previously to come.
tion of FASB Accounting Standards had reflected earnings before interest, Through strategic use of the new
Codification (ASC) Topic 606, Rev- taxes, depreciation, and amortization revenue recognition standards, however,
(EBITDA). However, for tax years affected entities may be able to mitigate
enue From Contracts With Customers.
starting after 2021, Sec. 163(j)(8)(A)(v) some of the negative impact of Sec.
revises this calculation to reflect earnings 163(j)’s interest deduction limitation.
TCJA and the interest before interest and taxes (EBIT) — thus
expense deduction disallowing the addback of depreciation Topic 606 and interest income
First, some background may be help- and amortization. This change in calcu- Businesses can adopt a strategy based on
ful. Prior to the passage of the TCJA, lation will broaden the net of the interest the Topic 606 standards to help reduce
Sec. 163(j) had rules in place intended expense limitation, likely affecting many the negative effects of the business inter-
to prevent multinational entities from entities that had narrowly escaped the est limitation. The strategy discussed
using interest expense as a method of limitation in earlier years. here involves reclassifying certain reve-
shifting earnings to lower-income-tax Any interest expense beyond the nue as business interest income. Business
jurisdictions and avoiding U.S. taxation. amount of the interest limitation is not interest income, as noted above, is in-
This original guidance only limited deductible in the current year but can cluded in the interest limitation calcula-
interest expense paid to certain entities be carried forward indefinitely to offset tion at 100%, while traditional revenues
and only under specific conditions. As a future taxable income. However, because flow into adjusted taxable income, which
result, most U.S.-based taxpayers were the value of disallowed carryforward in- is counted in the interest limitation cal-
able to deduct the entire amount of or- terest will be included as interest expense culation at only 30%. As a result of the
dinary interest expense to calculate their of the future year, it will still be subject to reclassification, therefore, a company in-
taxable income. the same interest expense deductibility creases the deductible amount of interest
With the TCJA’s amendment to Sec. rules. While the idea of carrying forward expense by up to 70 cents for each dollar
163(j), a business’s deduction for interest this excess expense sounds beneficial, recognized as interest income instead of
is now limited to the sum of: the tax benefit is unlikely to be realized traditional revenues.

1. P.L. 115-97. 3. Coronavirus Aid, Relief, and Economic Security Act, P.L. 116-136, §2306(a).
2. Sec. 163(j)(3).

www.thetaxadviser.com June 2022 27