Adding Section 163(n) Would Mean a Sea Change for Businesses

If you’ve pored over the Build Back Better Act (BBBA) legislation and become perplexed over the proposed changes to Section 163 of the tax code, you’re not alone. BBBA includes a provision that would add Section 163(n), which is designed to bring about a sea of change in the way enterprises operate in the US.

In short, Section 163(n) would limit the tax deduction for interest expenses that exceed interest income to an “allowable percentage” that equates to 110% of the excess. This rule would apply to all US corporations that are members of a multinational group that prepares consolidated financial statements—and has averaged more than $12 million per year in net interest expenses for a reporting period of three years. It’s important to note that both US subsidiaries of foreign groups and US groups would need to comply. These changes would take effect after Dec. 31, 2022.

Of course, it is unclear whether this or any other provision of the legislation will ever actually be enacted. We all know that BBBA has been kicked around Washington like the proverbial political football. However, the Section 163(n) proposal makes two things very clear to me and, I hope, to all US tax professionals.

Corporates Will Face Greater Profitability Challenges

First, the new limits on interest expense deductions in Section 163(n), if enacted as written, could have a massive, adverse financial impact on the long-term profitability of larger US corporates and their business groups, particularly those that rely on third-party debt. The costs of taking on new debt to make key investments and grow the business, as well as servicing existing debt, could rise significantly absent mindful planning.

Second, Section 163(n) would make the US an outlier with a tax regime likely seen as punitive by corporate taxpayers. To date, the majority of nations have reached consensus, at least in principle, on OECD Pillars One and Two, which are designed to ensure that “multinational enterprises pay a fair share of tax wherever they operate.”

For example, in early April, 26 of 27 EU member nations expressed support for the global minimum tax proposed as part of Pillar Two, with Poland being the only holdout. As the world clearly moves closer to widespread agreement on revamping the overall corporate tax framework, proposed Section 163(n) would take the US in the opposite direction. Nowhere in the world do similar limits on interest expense deductions exist as laid out in BBBA. If Section 163(n) becomes law, it is logical to assume that corporates will seek third-party financing in more tax-efficient jurisdictions. In fact, given the potential for significant revenue impacts, some corporates may be obligated to move offshore to maintain value for their shareholders. Is it likely this will result in a net loss of tax revenue, jobs, and innovation in the US? That remains to be seen, but it bears consideration by all stakeholders.

Another possible unintended consequence involves the negative effects on capital-intensive industries that tend to rely most on debt financing: energy, utilities, transportation, telecommunications, and financial services. It’s no surprise that these are the US verticals most crucial to reducing greenhouse gases, fighting climate change, and funding sustainability solutions. The US continues to hold the unenviable title of world’s leading producer of greenhouse gasses per capita. As such, do we want to enact policies that could potentially discourage these types of businesses from investing in innovations to help our country help the planet?

How We Got to This Point

The proposed Section 163(n) marks another step in a larger, multiyear trend characterized by lawmakers’ and tax authorities’ fervent commitment to increase taxes on corporations and high-net worth individuals and families. In this environment, it’s critical that we as tax professionals recognize the reality of economic inequality between countries and people.

Since the OECD first proposed its two-pillar plan, the Covid-19 pandemic has exacerbated these inequalities and, some say, turned back nearly 20 years of progress in bridging these gaps. Some 120 million people around the world “have been pushed into extreme poverty” in recent years, according to the International Monetary Fund. Simultaneously, the Thiel Index, a measure of international income inequality, showed a significant increase in the disparity between the richest and poorest nations from 2019 to 2021. These ideas have provided added impetus to global influencers’ calls for continued tax overhauls. In an article for the World Economic Forum, Oxfam International Executive Director Gabriela Bucher proposed a one-time 99% “windfall tax” on the pandemic wealth gains of the 10 richest men in the world. (It’s so unfortunate there are no women on the list, but that’s another topic for another day.)

However, in our drive to create a more level playing field, we must be wary of throwing up too many tax-related roadblocks for private enterprise to invest in the people and technology needed to grow the world economy from its pandemic nadir. In late 2021, a report from the Congressional Research Service showed worldwide capital losses between 2020 and 2022 at $18 trillion, roughly 20% of 2019 global GDP. Rescuing our planet from this crisis may well require increased tax revenue to enable the public sector to respond. But should this not be done in a coordinated manner versus via unilateral levies such those proposed in Section 163(n)?

Planning Ahead

While the debate continues, what can corporates do to prepare for this possibility? For any entity that relies on third-party financing, contingency planning begins with modeling all factors that impact the company’s effective tax rate (ETR). These include US and global earnings before interest, taxes, depreciation, and amortization (EBITDA); net interest expenses; and other components necessary to arrive at the “allowable percentage” specified under 163(n).

A comprehensive analysis should also include how much debt is being held in every tax jurisdiction, along with the possibilities of carrying forward US debt-interest deductions and the effects on profitability. This leads to iterative scenario planning involving potentially moving debt to more tax-efficient jurisdictions and the impacts on a company’s ETR. Further planning considerations around offshore debt and other third-party financing arrangements that have potential to generate higher benefit and yield could prove to be more attractive options for these big businesses.

We recognize that US leaders are seeking to include provisions in legislation such as BBBA that promise to rebuild our economy and construct a more sustainable world. However, when it comes to troubled or challenging concepts such as Section 163(n), we need to be cautious about enacting policy that removes incentives for successful businesses to operate and invest in the US—and truly build all of us back better.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Tifphani White-King is the National Tax Practice leader for Mazars in the US. She has over 25 years of experience delivering insightful international tax structuring, transaction planning, mergers and acquisitions, tax provision, compliance reporting, and other related services.