handbook-tb

Limiting interest deductions3.1.3.3 Net interest or gross interest? Net debt or gross debt?One important issue is veiled in the discussion above: in seeking todetermine whether a taxpayer has excessive interest, such that someportion of the interest expense should be disallowed,‣ ¾ Should the debt/equity test be based on gross debt (treatingcash as an asset) or net debt (such that gross debt is reduced bycash); and‣ ¾ Likewise, should the calculation whether an enterprise incursinterest expense in excess of a prescribed limitation be made onthe basis of gross interest expense or net interest (gross interestexpense minus interest income)?There is, of course, no single right answer. And both approachesare readily administrable, since the data required to apply eitherapproach lies in the financial statements and tax return information.There are differences in the two approaches, however. Forinstance, a taxpayer may have high debt, but also high cash balances.Should interest payments on the debt be viewed as excessive and baseeroding,or does the fact that the company has available cash (whichmay be earning interest income) dampen any tax concern aboutbase erosion?The key point for tax administrators and taxpayers to recognizeis that the question whether to adopt a test that uses gross debt andgross interest or net debt and net interest expense will have a majorimpact on what ratios or financial limitations should be adopted.3.1.3.4 Tax treatment of disallowed interestAssuming that a taxpayer has “excess” interest in a taxable year, thequestion arises whether the excess amount should be permanentlydisallowed as an interest deduction, or whether the interest should becarried forward and allowed as a deduction in a future year, when thetaxpayer fully satisfies the limitations on interest expense.Because of business cycles, some measure of carry-forward maybe appropriate. The interest expense would be allowable in the future171