20 May 1993 T.I. (Tax Window, No. 31, p. 3, ¶2509)

Where funds are loaned by FA1 to FA2, which carries on business in the U.S. and, due to the application of the excess interest rule in s. 163(j) of the IRC, FA2 is unable to claim a current deduction for the interest paid to FA1, the full amount of the interest received will be active business income to FA1 and included in its earnings for purposes of Regulation 5907(1)(a)(ii). However, only the portion of the interest paid which is actually deducted by FA2 will reduce its earnings under Regulation 5907(1)(a)(i). Regulation 5907(2)(j)(i) would not be applicable in computing the earnings of FA2 for the year that the interest is paid because s. 163(j) only defers the deduction. However, Regulation 5907(2)(j)(i) would apply if FA2 was sold prior to claiming the deduction for the interest paid to FA1 or if the interest deduction was applied to passive income.

Where funds are lent by FA1 to a second foreign affiliate (FA2) which carries on business in the U.S., and due to the application of the excess interest rule in s. 163(j) of the IRC, FA2 is unable to claim a current deduction for the interest paid to FA1, Regulation 5907(2)(j)(i) will not be applicable in computing the earnings of FA2 for the year the interest is paid because s. 163(j) only defers the deduction. However, the Regulation would apply if FA2 is sold prior to claiming the deduction for the interest paid to FA1 or if the interest deduction were applied to passive income.