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US — Orbitax Tax News & Alerts
Court of Appeals confirms that interest deduction disallowance does not violate 1967 US-France tax treaty

The US Court of Appeals for the Seventh Circuit has confirmed a decision of the US Tax Court that the interest deduction disallowance rule of Treasury Regulation § 1.267(a)-3 does not violate Art. 24(3) (Non-discrimination) of the 1967 US-France tax treaty (Square D Company v. Commissioner, Docket No. 04-4302, 13 February 2006).

Treasury Regulation § 1.267(a)-3 prevents US taxpayers from claiming a tax deduction for an expense owed to related foreign persons until such time as the expense is actually paid. The effect of the Regulation is to require US taxpayers to use the cash method of accounting rather than the accrual method of accounting for expenses owed to related foreign persons.

The taxpayer in the case was a US corporation (Square D) that was wholly owned by a French multinational (Schneider S.A.). Square D claimed a tax deduction for interest expenses that were accrued and owed to Schneider S.A. and related parties, but which had not yet been paid. The deductions for the interest expenses were disallowed by the Internal Revenue Service (IRS) on the basis of the Regulation.

The US Court of Appeals held that the Treasury Regulation § 1.267(a)-3 was a permissible interpretation of the underlying statute and did not violate Art. 24(3) (Non-discrimination) of the 1967 US-France tax treaty, which disallows discrimination based on foreign ownership. The US Court of Appeals, however, determined that the Regulation disallowed the deduction based on the nationality of the related party receiving the payment rather than on the nationality of the owner of the US subsidiary.