USA Law and Practice Contributed by: Nicholas A Dorsey, Ryan J Patrone, Kelly M Smercina and Margaret R M Rallings, Cravath, Swaine & Moore LLP
themselves of these treaty benefits. For foreign lenders organised in non-treaty jurisdictions, the so-called “portfolio interest exemption” often eliminates withholding for interest paid to an unrelated foreign lender that is not a bank. It is market standard in US deals for lenders to certify exemption from withholding tax when the loan is established. Loan documents typically allocate change in law withholding risk to the borrower, but this is not currently viewed as a substantial risk. The USA also has comprehensive information reporting rules, known as the Foreign Account Tax Compliance Act (FATCA). Under FATCA, for- eign lenders are required to provide information and certification to US borrowers. The penalty for not doing so is a 30% withholding tax. 8.3 Thin-Capitalisation Rules Limitation on Business Interest Deductions For decades, thin-capitalisation (or “thin-cap” ) rules have limited a US taxpayer’s interest deductions under certain circumstances. The Tax Cuts and Jobs Act of 2017 (TCJA) signifi- cantly broadened the scope of the thin-cap rules to cover all debt (not just related party debt), and also tightened the limit on interest deductions subject to the rules. The TCJA generally limits a US taxpayer’s net business interest deductions to 30% of its “adjusted taxable income” , which corresponds roughly to the taxpayer’s EBIT (in years prior to 2022 it corresponded to EBITDA). The cal- culation is performed on a consolidated basis for groups, and “business interest” is defined broadly to generally include all interest that is allocable to the group’s trade or business.
If any of a US taxpayer’s interest deductions are disallowed, the taxpayer carries forward the deductions to subsequent tax years, where they are combined with current-year business inter- est expense and tested for deductibility based on that year’s EBIT. If, by contrast, the US tax- payer does not have enough interest expense in a given year to use all of its capacity, the excess capacity does not carry forward and is simply lost. These rules generally apply to all taxpayers except small businesses and certain real prop- erty, farming and regulated utility entities. Spe- cial computational rules apply to borrowers that are partnerships and S corporations, with some- times surprising results. Note also that additional rules may restrict the deductibility of interest paid on certain subordi- nated debt or debt that is issued at a substantial discount. Section 956 Issues US borrowers whose foreign subsidiaries pro- vide guarantees or asset pledges as credit support have historically faced negative US tax consequences. However, under the TCJA, these negative tax consequences have gener- ally been eliminated where the US borrower is a corporation and the foreign subsidiaries oper- ate only non-US businesses. The TCJA has also allowed for these negative consequences to be more easily managed in certain other contexts. Even under the TCJA, careful planning may be required (and income inclusions may be una- voidable) where the US borrower is a partner- ship with non-corporate partners, or if hybrid entities or instruments are involved or in the unlikely event the foreign subsidiaries have US operations.
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