Part II—Tax on Excess Interest

If a foreign corporation is engaged in a U.S. trade or business, has effectively connected gross income, or has U.S. assets for purposes of Regulations section 1.882-5, it is subject to the tax on excess interest.

Excess interest is the interest apportioned to ECI of the foreign corporation (including capitalized and nondeductible interest) under Regulations section 1.882-5, less branch interest. Branch interest is the interest paid by the U.S. trade or business of the foreign corporation (including capitalized and other nondeductible interest).

Important. See the instructions for line 10, later, to determine if the foreign corporation is exempt from the tax on excess interest. If it is exempt from the tax, and not simply subject to a reduced rate of tax, do not complete Part II of Section III. However, be sure to complete item W(1) on page 2 of Form 1120-F.

Line 7a Enter the amount of interest expense deduction allocable to ECI under Regulations section 1.882-5, from Section II, line 18.

Lines 7b and 7c Lines 7b and 7c reconcile the deduction claimed in Section II, line 18, with the amount of interest expense allocable to ECI under Regulations section 1.882-5. Amounts that increase or decrease the amount allocable to ECI are reported on line 7b from Schedule I (Form 1120-F), line 24g. Line 7c reconciles to the amount of interest expense reported on Schedule I (Form 1120-F), line 23. Lines 7b and 7c are completed as follows. Line 7b. Enter the inverse of the amount reported on Schedule I (Form 1120-F), line 24g. For example, if line 24g is negative, enter as a positive number. If line 24g is positive, enter as a negative number. This is the total amount of interest expense included in the amount allocable under Regulations section 1.882-5 that is deferred, capitalized, and disallowed under other sections after application of the interest expense allocation rules.

Line 7c. Combine lines 7a and 7b. The combined amount is the amount of interest expense allocable to ECI for the year under Regulations section 1.882-5. The amount on line 7c must equal the amount on Schedule I (Form 1120-F), line 23.

Line 8. Branch Interest

Foreign banks. Enter from Schedule I (Form 1120-F) the sum of line 9, column (c), and line 22, which is the amount of interest expense included on books that give rise to U.S. booked liabilities and that is directly allocable to ECI under Regulations section 1.882-5(a)(1)(ii). The sum of these two amounts is the amount of book interest expense paid or accrued on U.S. booked liabilities defined in Regulations section 1.882-5(d)(2).

Definition of branch interest. The term “branch interest” means interest that is:

1. Paid by a foreign corporation with respect to a liability that is (a) a U.S. booked liability within the meaning of Regulations section 1.882-5(d)(2) (other than a U.S. booked liability of a partner within the meaning of Regulations section 1.882-5(d)(2) (vii)), or (b) described in Regulations section 1.884-1(e)(2) (relating to insurance liabilities on U.S. business and liabilities giving rise to interest expense that is directly allocated to income from a U.S. asset); or

Instructions for Form 1120-F (2025) 33

2. In the case of a foreign corporation other than a bank (as defined in section 585(a)(2)(B) without regard to the second sentence thereof), a liability specifically identified as a liability of a U.S. trade or business of the foreign corporation on or before the earlier of the date on which the first payment of interest is made with respect to the liability or the due date (including extensions) of the foreign corporation’s income tax return for the tax year provided that (a) the amount of such interest does not exceed 85% of the amount of interest of the foreign corporation that would be excess interest before taking into account interest treated as branch interest; (b) certain recipient notification requirements are satisfied; and (c) the liability was not incurred in the ordinary course of a foreign business or secured by foreign assets, or is not a U.S. booked liability, or is not an insurance liability on a U.S. business, or is not a liability giving rise to interest expense that is directly allocated to income from a U.S. asset. See Regulations section 1.884-4(b).

All other foreign corporations. In general, branch interest of foreign corporations (other than banks) includes:

1. Interest on liabilities shown on the books and records of the U.S. trade or business for purposes of Regulations section 1.882-5(d)(2),

2. Interest on liabilities that are secured predominantly by U.S. assets or that cause certain nondeductible interest (such as capitalized interest) related to U.S. assets, and

3. Interest on liabilities identified as liabilities of the U.S. trade or business on or before the earlier of the date on which the first interest payment is made or the due date (including extensions) of the foreign corporation’s income tax return for the tax year.

However, a liability may not be identified under 3 above if the liability is incurred in the ordinary course of the foreign corporation’s trade or business, or if the liability is secured predominantly by assets that are not U.S. assets. The interest on liabilities identified in 3 above that will be treated as interest paid by the U.S. trade or business is capped at 85% of the interest of the foreign corporation that would be excess interest before considering interest on liabilities identified in 3 above. See Regulations section 1.884-4.

Interbranch interest. Any interest paid for interbranch liabilities is disregarded in computing branch interest of any corporation.

80% rule. If 80% or more of a foreign corporation’s assets are U.S. assets, the foreign corporation’s branch interest will generally equal the interest reported on line 7c. However, any interest included on line 7c that has accrued but has not been paid will not be treated as branch interest on line 8 unless an election is made under Regulations section 1.884-4(c)(1) to treat such interest as paid in that year for all purposes of the Code.

If this 80% rule applies, check the box on line 8.

Note: Branch interest of a foreign corporation is treated as if paid by a domestic corporation. A foreign corporation is thus required to withhold on interest paid by its U.S. trade or business to foreign persons (unless the interest is exempt from withholding under a treaty or the Code) and is required to file Forms 1042 and 1042-S for the payments.

Special treaty shopping rules apply if the recipient of the interest paid by the U.S. trade or business is a foreign corporation.

Line 9b A foreign bank may treat a percentage of its excess interest as if it were interest on deposits and thus exempt from tax. Multiply the amount on line 9a by the greater of 85% (0.85) or the ratio of the foreign bank’s worldwide interest-bearing deposits to its

worldwide interest-bearing liabilities as of the close of the tax year.

Line 10. Tax on Excess Interest The rate of tax on excess interest is the same rate that would apply to interest paid to the foreign corporation by a wholly owned domestic corporation. The tax on excess interest is not prohibited by any provision in any treaty to which the United States is a party. The corporation may qualify for treaty benefits if it meets certain requirements. See Line 6 , earlier. The corporation is exempt from the tax on excess interest if the rate of tax that would apply to interest paid to the foreign corporation by a wholly owned domestic corporation is zero and the foreign corporation qualifies for treaty benefits.