Question

FOco is a wholly owned manufacturing sibsidiary of USAco, a domestic corporation. USAco has been FORco's sole shareholder since FORco was organized. At the end of the current year, USAco sells all of FORco's stock to an unrelated foreign buyer for $15 million, At that time, FORco had $3 million of undistributed earnings and profits and $1 million of foreign income taxes. USAco's stock was $10 million prior to the sale. Assuming the US corporate tax rate is 21%, what are the US tax consequences to USAco?

Answer 1

The US federal income tax provisions under IRC Section 267(a)(3) (Matching Rule) and IRC Section 163(j) (Earnings Stripping Rule) must be satisfied before the interest expense realized by the US subsidiary can be deducted. Applying IRC Section 267 generally defers the deductibility of interest until such time as it is actually paid, as opposed to merely accrued. IRC Section 163(j) limits the deduction for interest on certain types of related-party debt (or debt that is guaranteed by a foreign related party) if the debt to equity ratio exceeds 1.5:1.0 and there is excess interest expense. Generally speaking, if interest expense is less than one-half of annual cash flow (i.e., cash-basis EBITDA), there should not be “excess interest expense.” If the earnings stripping rules apply, then any excess interest expense cannot be deducted until a later year.

1. First of all, as per thhe above rule if the interest expnese is not yet paid and just accrued then it will not be deductible in this year and may be deductible in the year in which it ois paid.

2. Secondly, if the interest is less than one-half of the EBITDA, then there will not be excess interest expense. So below mentioned is the calculation of EBITDA:

Gross Income	1500
Less: Admistrative Expenses	1250
EBITAD	250

Now, the Earning before interest, depreciation and tax is less than the interest expense. The same will be deductible in later years.