MLR

‘Payback’ to foreign parent company isn’t an interest deduction

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The IRS concluded that amounts paid by a U.S. corporation to its foreign parent were not deductible as interest since the U.S. corporation, in effect, borrowed from its parent to make those payments.

As explained in a Chief Counsel Advice (CCA 201334037), the U.S. corporation maintained a general account into which it deposited amounts derived from all sources, including advances from third-party banks under lines of credit, active business income and advances from its foreign parent. Funds were withdrawn from this account to pay day-to-day operating costs.

Periodically, funds were withdrawn from this account to make payments to the foreign parent. These payments were characterized as payments of interest on advances from the parent. Funds sufficient to cover these payments were obtained shortly before or shortly after the disbursement, either through additional loans from the parent or pursuant to draw-downs on one or more lines of credit with the parent.

The related-party rules of Internal Revenue Code Section 267 authorize the IRS to provide regulations that limit the deductibility of payments to foreign persons. Those regulations provide that payments to a foreign related party are not deductible until that amount is treated as paid to the foreign person.

The IRS found that the U.S. corporation’s payments were not deductible as interest because it borrowed for the purpose of paying the interest. The IRS noted that, when funds are (in form) loaned by the foreign parent to the U.S. corporation and “paid back” via return wire transfers, the resulting “U-turn” transaction is one that changes neither the economic position of the lender nor the borrower.