Academic journal article Journal of Accountancy

Clinton Aims at Earnings Stripping

Academic journal article Journal of Accountancy

Clinton Aims at Earnings Stripping

Article excerpt

Practitioners dealing with multinational clients take note: President Clinton recently made it clear he intends to get tough on earnings stripping - a colorful term for a practice foreign corporations have engaged in since the 1980s, when leveraged buyouts were common.

Earnings stripping occurs when, for tax purposes, a foreign corporation's U.S. subsidiary deducts interest it paid on debt owed to the parent. Since the parent company is exempt from paying U.S. income tax, the IRS doesn't receive its piece of the pie.

Section 163(j), in force since July 10, 1989, says affected companies are not allowed to deduct interest expenses paid to their foreign parent companies. Affected companies have (1) "excess interest expense" (net interest expense over 50% of cash flow) and (2) a debt-to-equity ratio of greater than 1.5 to 1.

The lesser of such "excess interest expense" or "exempt related-party interest" (interest paid to a related foreign party) is disallowed. However, the tax code contains an exemption for certain existing indebtedness - debt with a fixed term that was issued on or before July 10, 1989, or, generally, debt that is merely guaranteed by the exempt foreign parent company.

All in all, this rule is considered to be reasonably fair by affected foreign corporations but hardly beneficial to them.

As has been the case in recent months, President Clinton added yet another twist to the story - one that takes away the exemptions while confusing and angering many. …

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