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Interest stripping regulations create unexpected affiliated groups.

Prop. Regs. Sec. 1.163(j)-5(a)(3) provides a special rule resulting in the creation of an affiliated group where affiliated group status would not otherwise exist for Sec. 163(j) earnings stripping purposes. Consider, for example, the situation in which a U.S. corporation (USP) owns 100% of U.S. subsidiary A and 60% of U.S. subsidiary B. As drafted, Prop. Regs. Sec. 1.163(j)-5(a)(3) would apply the Sec. 318(a)(2)(C) attribution rules resulting in an affiliated group for earnings stripping purposes consisting of USP, A and B. This would result even though a less-than-80% indirect ownership link exists between A and B.

Consider also, for example, a situation in which foreign parent corporation F owns 100% of U.S. subsidiary A, which owns 60% of U.S. subsidiary B. F also owns 100% of U.S. subsidiary C. Without modification, Prop. Regs. Sec. 1.163(j)-5(a)(3) results in A, B and C being treated as members of the same affiliated group for earnings stripping purposes.

Similarly, the equity investments of venture capital funds and investment bankers (operating as a partnership) may be treated as members of a single affiliated group. Given the current economic climate, many companies are having difficulties borrowing funds and raising capital through public offerings. As a consequence, venture capital firms and investment bankers are providing their portfolio of companies with relatively large amounts of capital and taking, in many cases, a greater-than-50% equity interest in such companies. Under the Sec. 318 attribution rules reference in Prop. Regs. Sec. 1.163(j)-5(a)(3), such companies may be treated as a single taxpayer for Sec. 163(j) purposes.

As a result, the books and records of companies so affected would have to be shared among such companies in order to perform the calculations required under Sec. 163(j). For companies included in the portfolio of a venture capital fund or investment banker, the individual companies are distinctly separate and independent business interests, and would not freely share books and records for tax reporting purposes.
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Author:Plutte, Kerry L.
Publication:The Tax Adviser
Date:Jan 1, 1992
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