The New York State Department of Taxation and Finance has issued a Technical Memorandum under the Article 9-A corporate franchise tax providing a method for attributing interest expense deductions for corporations impacted by the federal interest deduction limitations under IRC § 163(j), and for corporations with deemed repatriated income under IRC § 965(a). Technical Memorandum, “Attribution of Interest Deductions for Article 9-A Taxpayers with Repatriated Income or IRC § 163(j) Limitations,” TSB-M-19(2)C, (2) I (N.Y.S. Dep’t of Taxation & Fin., June 12, 2019).
Under Article 9-A, since a corporation is not taxed on its investment income, other exempt income (including exempt CFC income), and exempt unitary corporation dividends, a corporation’s interest expenses attributable to those categories of income are disallowed. The Memorandum provides important guidance on this frequently troublesome area of New York corporate tax law, an area made more complex by the interplay of the interest attribution rules and IRC § 163(j), which generally limits a taxpayer’s federal deduction for net business interest to 30% of its adjusted taxable income for the year.
IRC § 163(j) Interest Expense Limitation
For taxpayers impacted by the IRC § 163(j) interest expense limitation, the Memorandum provides a method for determining the interest expense attribution amounts after application of the § 163(j) limitation. First, it requires that a corporation calculate the amount of interest expense subject to attribution prior to the § 163(j) limitation and the portion of that amount that is directly attributable to each category of income under Article 9-A (“directly traceable amounts”). It then requires that the corporation calculate the total amount of interest expense subject to attribution after the § 163(j) limitation (“limited interest amount”).
The Memorandum explains how the limited interest amount should be attributed to each category of income. If the directly traceable amounts (pre-application of the § 163(j) limitation) are greater than the limited interest amount (post-application of the § 163(j) limitation), the directly traceable amounts must be recalculated for each category of income by multiplying the limited interest amount by a fraction for each income category, the numerator of which is the directly traceable amounts to that income category and the denominator of which is the pre-§ 163(j) limitation amounts traceable to all income categories. If the directly traceable amounts are less than (or equal to) the limited interest amount, then no adjustments must be made to the directly traceable amounts, and the excess interest expense is indirectly attributed to each category of income by formula.
IRC § 163(j) Carryforward Amounts
The Memorandum provides that IRC § 163(j) interest carryforwards may not be directly traced. Instead, those amounts are indirectly attributed by formula.
IRC § 965(a) Repatriation Amounts
The Memorandum also provides the methodology for attributing interest expenses to deemed repatriation amounts under IRC § 965(a). If the CFC stock generating the repatriated income constitutes business capital to the taxpayer, no modification to the existing interest attribution method is needed. However, if the CFC stock constitutes investment capital to the taxpayer, the Memorandum provides for a modified method of calculating the attributable interest expenses.
The new guidance is important in that it reconciles directly attributed interest expenses (which are pre-limitation) with the interest expenses actually deducted (which are post-limitation). The IRC § 163(j) interest expense attribution methodology does not apply to taxpayers that have made the 40% interest expense “safe harbor” election, an annual election that generally allows a corporation to add back 40% of its investment income, exempt CFC income, and exempt unitary dividends in lieu of being subject to direct and indirect interest expense attribution.