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Avoiding group interest allocation.


Ford Motor Company has limited the impact of the 1986 Tax Reform Act's consolidated interest expense allocation rules by deconsolidating its highly leveraged subsidiary.

Under those rules, interest expense incurred by one member of an affiliated group can be allocated to the foreign source income of another member. Consequently, the ratio of foreign source to U.S. source taxable income can be reduced in computing the foreign tax credit limitation of the group. The result is a reduction in available foreign tax credits.

Before the 1986 act, interest expense was allocated only between the U.S. and foreign source income of the affiliated group member that actually did the borrowing. Affiliated groups were thus able to isolate their borrowings in those corporations with only U.S. assets and income. Interest expense then was allocated only against U.S. source income.

Ford has two businesses: manufacturing (principally automotive-related) and financial services. The financial services business is highly leveraged and produces primarily U.S. source income, while the manufacturing business is less leveraged and produces a substantial amount of foreign source income. The new rules would allocate a portion of the finance business's interest expense to the foreign source income generated by the manufacturing business.

To avoid this, Ford placed its financial services subsidiaries under a subsidiary holding company. The holding company then issued to unrelated institutional investors preferred stock with voting power and value in excess of 20% of the vote and value of all its outstanding stock. Since the Ford group no longer owned at least 80% of the holding company's stock (by vote or value), the financial services subsidiaries ceased to be members of the same group as the manufacturing corporations for consolidated interest expense allocation purposes. As a result, the interest expenses of the financial services business no longer reduced the foreign source income of the manufacturing business.

Observation: Because the value of the preferred and common stock may fluctuate, Ford's interest could reach 80% in the future. The company therefore provided for a dividend rate on the preferred stock high enough to maintain its value. Nevertheless, other steps (such as the issuance of additional preferred stock) may be required.

Beware that under the Ford technique, other tax attributes of the unaffiliated corporation (for example, its income and losses) cannot be consolidated with the other group members' attributes.

Herbert M. Paul, CPA, senior partner of Mahoney, Cohen, Paul & Co., New York City; Robert Willens, CPA, senior vice-president-corporate finance at Shearson Lehman Hutton, New York City; and Marianne Burge, CPA, partner, international tax services, at Price Waterhouse, New York City.
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Author:Burge, Marianne
Publication:Journal of Accountancy
Date:Mar 1, 1990
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