Academic journal article Journal of Accountancy

Final Regulations: CFC Netting Rule

Academic journal article Journal of Accountancy

Final Regulations: CFC Netting Rule

Article excerpt

The IRS issued final regulations on directly allocating unrelated party interest expense to interest income from related controlled foreign corporations (CFCs). This is commonly referred to as the CFC netting rule. The regulations are effective for taxable years beginning after December 31, 1991, but may be applied on an elective basis to all taxable years beginning after December 31, 1987.

The United States allows taxpayers to take a U.S. tax credit for foreign taxes paid or incurred, or deemed so. However, this credit is limited to the amount of U.S. tax attributable to the taxpayer's foreign source income.

In order to determine net foreign source income, the taxpayer must allocate expenses between U.S. and foreign sources. In particular, a U.S. affiliated group of corporations generally must allocate interest expense based on the relative value of foreign and U.S. assets.

The CFC netting rule was intended to stop abuse of this rule when U.S. taxpayers borrowed from unrelated entities to make loans to related CFCs rather than have the CFCs borrow directly. This shift in financing resulted in an increase in the net foreign source income of the U.S. affiliated group (and, therefore, an increase in its foreign tax credit limit).

Under the final regulations, an abuse is considered to have occurred when the U. …

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