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In brief

Generally, an affiliated group allocates and apportions its interest expense in determining foreign-source taxable income as if all members of the group are a single corporation. Only domestic corporations are included in the affiliated group with the result that a US-based multinational with a significant portion of its assets overseas is required to allocate a significant portion of its interest expense to foreign-source income. This may cause an over-allocation of interest expense to foreign-source income, thereby reducing foreign-source taxable income and limiting the foreign tax credit.

As part of the American Jobs Creation Act of 2004, Congress enacted a one-time, elective provision in which the foreign-source taxable income of the domestic members of a worldwide affiliated group is determined by allocating and apportioning interest expense of the domestic members on a worldwide group basis (i.e., as if all members of the worldwide group were a single corporation) (“worldwide interest expense allocation”). The result is that interest expense of foreign members of a worldwide affiliated group is considered in determining whether a portion of the interest expense of the domestic members of the group must be allocated to foreign-source income. An allocation to foreign-source income generally would be required only if the domestic members of the group were more highly leveraged than the entire worldwide group.

The worldwide interest expense allocation originally was scheduled to be effective beginning in 2009.  Congress, on numerous occasions, delayed its effective date with the final delay to taxable years beginning after December 31, 2020.   As part of the drafting of the Tax Cuts and Jobs Act (“TCJA”), the Senate accelerated the effective date for worldwide interest expense allocation by three years to taxable years beginning after December 31, 2017.  One of the rationales for doing so was that the loss of the benefit of worldwide interest expense allocation (through delays in its effective date) was offset by the benefit of the compound source rule for goods produced in the United States and sold abroad.

Generally, under the compound source rule, 50% of the income on the sale of the produced goods was US-sourced (place of production) and 50% was foreign-sourced (place of sale).  As part of TCJA, Congress repealed the compound source rule treating the source as entirely US (place of production).  Therefore, the Senate proposed to accelerate the effective date of worldwide interest expense allocation to correspond with the effective date of the repealed compound source rule.  The Senate’s effective date proposal, however, was not enacted as part of TCJA.

Near the end of 2020, US multinationals closely watched whether Congress would again delay the effective date of worldwide interest expense allocation, possibly as part of the Consolidated Appropriations Act, 2021.  Congress did not do so, and as a result, effective for taxable years beginning after December 31, 2020, a worldwide affiliated group may make an election to allocate and apportion interest expense of the domestic members on a worldwide basis.  Such an election, once made, applies to the common parent and all other corporations that are members of the worldwide affiliated group for such taxable year and all subsequent years unless revoked with the consent of the Secretary.  A calendar-year taxpayer (with a foreign subsidiary) makes the election with its 2021 return, which would be due in the year 2022.

Treasury and the IRS, in the preamble to the proposed foreign tax credit regulations released in December 2019, requested comments on the implementation of worldwide interest expense allocation noting that it “will have a significant impact on the effect of interest expense apportionment and will necessitate a reexamination of the existing expense allocation rules.”  In its 2020-2021 Priority Guidance Plan (dated November 17, 2020), Treasury and the IRS listed regulations on worldwide interest expense allocation.

After its enactment in 2004, electing worldwide interest expense allocation was thought to be beneficial to nearly all taxpayers.  Post-TCJA, however, with the new US international tax system, including global intangible low-taxed income, additional foreign tax credit baskets and rules, and the foreign branch rules, taxpayers will need to closely model the results of making such a one-time election.   In addition, adoption of worldwide interest expense allocation may have an effect on more than just the foreign tax credit calculation and limitation, as it may impact, for example, foreign-derived intangible income and the limitation on deduction of business interest.  Businesses will need to take into account the upcoming change in limitation to section 163(j) if Congress does not act.


Joshua D. Odintz is a partner in and on the management committee of Baker McKenzie’s North American Tax Practice Group. Joshua held high-level government positions with both the US Department of the Treasury and the Senate Finance Committee. He previously served as a Senior Advisor for Tax Reform to the Assistant Secretary at the US Department of the Treasury, where he advised Senior Treasury officials on tax reform options and issues. Joshua also served as the Chief Tax Counsel to the President’s National Commission on Fiscal Responsibility and Reform, and was instrumental in formulating the tax proposals that were contained in the Commission’s report, entitled the Moment of Truth. Additionally, Joshua served as the Acting Tax Legislative Counsel at the Treasury. Joshua is a frequent speaker at IFA, TEI, ABA Tax Section, NY State Bar Tax Section, Practicing Law Institute and Federal Bar Association tax meetings and conferences.


Alexandra Minkovich is a partner in Baker McKenzie's North American Tax Practice with more than fifteen years of experience handling a variety of tax, tax controversy, and legislative and regulatory matters. She also brings significant experience representing clients with respect to domestic tax issues, particularly in the life sciences, pharmaceutical, retail, and manufacturing industries, and is well versed in administrative law. Immediately prior to joining the Firm, Ms. Minkovich served as Associate Tax Legislative Counsel with the US Department of Treasury, Office of Tax Policy. In that role, Ms. Minkovich advised the Assistant Secretary (Tax Policy) and General Counsel regarding tax policy considerations in regulations and Internal Revenue Bulletin guidance, provided advice on tax legislative proposals, and provided litigation advice regarding the validity of Treasury and IRS guidance. She also provided technical comments on tax legislation to the Senate Committee on Finance and the House Ways & Means Committee, as well as to individual members’ offices. Ms. Minkovich speaks regularly at seminars and writes on a variety of topics related to legislative and regulatory developments, and administrative law.


Christopher H. Hanna joined Baker McKenzie as Counsel in January 2019. He is the Alan D. Feld Endowed Professor of Law and the Altshuler Distinguished Teaching Professor at Southern Methodist University. Professor Hanna has been a visiting professor at the University of Texas School of Law, the University of Florida College of Law, the University of Tokyo School of Law and a visiting scholar at the Harvard Law School and the Japanese Ministry of Finance. In 1998, Professor Hanna served as a consultant in residence to the Organisation for Economic Co-operation and Development (OECD) in Paris. From June 2000 until April 2001, he assisted the US Joint Committee on Taxation in its complexity study of the US tax system and, from May 2002 until February 2003, he assisted the Joint Committee in its study of Enron, and upon completion of the study, continued to serve as a consultant to the Joint Committee on tax legislation. From May 2011 until December 31, 2018, he served as Senior Policy Advisor for Tax Reform (Republican staff) to the United States Senate Committee on Finance, working extensively on the Tax Cuts and Jobs Act of 2017.