Tax Court rules out section 267 regulations.
Section 267(a)(2) generally allows a taxpayer to deduct expenses owed to a related person only when they are includable in the income of the payee according to the payee's method of accounting. This is known as the "matching principle." Section 267(a)(3) gave the Internal Revenue Service the authority to issue regulations that would apply the matching principle in the foreign context. The IRS issued regulations in 1992 generally allowing the payor to deduct payments on a cash basis only, because a withholding tax would be assessed on the payee as the payments leave the United States. These regulations were effective retroactively to 1984.
In Tate & Lyle, two U.S. corporations incurred interest expense on amounts borrowed from a parent corporation organized in the United Kingdom. The U.S. corporations deducted the interest the year it was accrued but paid it the following year. The IRS disallowed the accrual of the interest deduction, arguing that pursuant to section 267(a)(3) regulations, the interest should only be deductible in the year it is paid.
The court refused to apply section 267(a)(3) regulations for two reasons. First it said that the application of the regulations in this case to disallow the accrual of an interest deduction would go beyond the authority granted by Congress to write regulations applying the matching principle. This is because the payee was excluding the interest from income due to a treaty exemption, rather than deferring the income under an accounting method. Second, the court ruled that enforcing the retroactive application of section 267 regulations would violate the due process clause of the Fifth Amendment. Not only was the retroactive period excessive in length, but the 267(a)(3) regulations contained new rules that did not exist when the taxpayers filed their returns.
Observation: Although controversial, the court's decision not to apply the regulations is logical. There is no policy reason for delaying a deduction when the payee will not be subject to U.S. tax on the income due to an exemption, and it would be unfair for the United States to defer the interest deduction when the affiliated payee may be subject to tax in the current year in its home country. --Kenneth Kral, CPA, international tax partner, Jack Serota, Esq., international tax manager, and Elizabeth Alek, CPA, international tax consultant, at Price Waterhouse, New York City.
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|Publication:||Journal of Accountancy|
|Article Type:||Brief Article|
|Date:||Mar 1, 1995|
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