Problem:
Wheelco, a foreign corporation, manufactures motorcycles for sale worldwide. Wheelco markets its motorcycles in the United States through Wheely, a wholly-owned U.S. marketing subsidiary that derives all of its income from U.S. business operations. Wheelco also has a creditor interest in Wheely, such that Wheely's debt to equity ratio is 3 to 1, and Wheely makes annual interest payments of $60 million to Wheelco. The results from Wheely's first year of operations are as follows:
- Sales ............................................................................................. $180 million
- Interest income ............................................................................... $6 million
- Interest expense (paid to Wheelco).................................................................................. $60 million
- Depreciation expense....................................... .............................. ($30 million)
- Other operating expenses................................. .............................. ($81 million)
- Pre-tax income ................................................. ............................ $15 million
Assume the U.S. corporate tax rate is 35%, and that the applicable tax treaty exempts Wheelco's interest income from U.S. withholding tax.
Required:
Compute Wheely's interest expense deduction.