The branch interest tax is supposed to ensure that interest paid by a branch is not a form of profit stripping by a foreign parent. The statute starts out simply by deeming any interest that is allocated to the branch, but not actually paid, as being paid to the foreign parent. This amount is subject to the normal withholdings found in §881. While the regulations provide a large amount of discretion to the taxpayer to determine how much interest the branch pays, the amount that is attributable is set forth in more stringent guidelines. This provides for many planning techniques, which when used properly can help to minimize the amount of excess interest a branch incurs. One such planning technique is when to claim the accrued interest as being paid. Normally, the interest is claimed when it is paid, however, the use of an election allows for the interest payment claimed at the time of accrual. Even though this election can be claimed in a number of ways, if not claimed then it cannot be used as a defense, as shown in Taiyo Hawaii Company, Ltd. V. Commissioner. This paper will explore the mechanics of how interest is allocated, and how any excess amount is determined. Once the mechanics are clarified, planning options will be discussed, with an emphasis on the accrual election and the election to reduce assets and liabilities that are associated with the branch.
The Workings of § 884
When determining the branch interest tax, one must determine how much of the foreign corporation’s interest can be allocated to the branch’s effectively connected income. In general this amount is treated as if a domestic corporation paid it. (§884(f)(1)(A)) All rules that normally apply to interest paid by a domestic corporation now apply to the interest paid by the branch. The interest could be considered portfolio interest and exempt from withholdings under §881(c) if the branch is not a bank and unrelated to the payee. If the interest is paid to a foreign persons, then the terms of any related treaty would apply, possibly lowering the withholding tax.
The second part of §884(f)(1) is concerned with any interest that is allocated to the branch, but exceeds the amount paid by the branch. This excess is considered as interested paid to the foreign parent by a wholly owned domestic corporation. (§884(f)(1)(B)) Since the interest is paid by a wholly owned subsidiary, it is not considered portfolio interest. This requires that any eligible withholdings should be applied to the payment. If the recipient is a qualified resident of a country with an active income tax treaty, then the withholdings amount will comply to the amount set forth by the treaty. §884(f)(3)
The next step is to determine what interest is allocable to the branch.