What Is Section 267(a)(3)? Matching Rule and Accrual Exceptions

Section 267(a)(3) of the Internal Revenue Code requires an accrual-method U.S. taxpayer to postpone deducting interest, rents, royalties, management fees, service charges, and similar amounts owed to a related foreign person until the money is actually paid. The deduction isn’t lost. It’s just deferred out of the accrual year and into the year of payment, which erases the timing advantage a U.S. payor would otherwise get from accruing an expense the foreign recipient hasn’t yet reported as income.¹

How the Matching Rule Works

Section 267(a)(2) is the general matching rule. When an accrual-method payor owes a deductible amount to a cash-method payee who happens to be a related party, the payor cannot deduct the expense until the payee includes it in gross income. That keeps a U.S. company from claiming a current deduction against income the related recipient won’t report for another year or two.²

Section 267(a)(3) extends that principle to related payees who are not U.S. persons. The statute directs Treasury to apply matching by regulation, and the regulations do it by borrowing the cash-method timing rule: the payor deducts when the amount is paid, not when it’s accrued.³

The scope is broad. Any otherwise deductible amount owed to a related foreign payee falls in: intercompany interest, royalties on licensed IP, cross-border management fees, service charges, rent on foreign-held property leased into the U.S. group. If it would have been deductible on accrual, it now waits for cash.

Which Relationships Trigger the Rule

None of this matters unless the payor and payee are “related persons” under Section 267(b). The list runs to thirteen categories, but for cross-border planning the ones that come up over and over are: an individual and a corporation where the individual owns more than 50% of the stock by value; two corporations that are members of the same controlled group; and a corporation and a partnership where the same persons own more than 50% of each.⁴ Family, trust, and estate relationships fill out the rest of the list.

Direct ownership isn’t the whole test. Section 267(c) attributes stock from entities to their owners proportionately, and from an individual to their spouse, siblings (whole or half blood), ancestors, and lineal descendants. Attribution routinely pushes a shareholder over 50% who wouldn’t get there counting only shares in their own name. One limit is worth knowing: stock attributed to an individual through family or partner attribution can’t be re-attributed to another family member or partner, but stock attributed through an entity is treated as actually owned and can be attributed again.⁵

Payments to Foreign Related Parties

The core scenario is a U.S. subsidiary accruing interest, royalties, or management fees owed to a foreign parent or affiliate. The subsidiary cannot deduct those amounts on its return until it actually pays them. Year-end accruals followed by cash settlement months later produce a deduction in the payment year, not the accrual year.³

“Paid” borrows its meaning from the withholding tax rules under Sections 1441 and 1442. An amount is treated as paid when it would be considered paid for withholding purposes: funds transferred, credited to the payee’s account, or otherwise made available so the payee has an unrestricted right to them.³ Book accruals, journal entries, and unpaid intercompany balances don’t get you there.

Exceptions That Let You Deduct on Accrual

The regulations carve out several situations where the mismatch the statute worries about doesn’t actually exist, and in those cases the payor can keep accrual-method timing.

Effectively Connected Income

If the foreign payee earns the income in connection with a U.S. trade or business, it’s effectively connected income (ECI) and gets taxed on a net basis. The foreign recipient is already on the hook for U.S. tax on the accrued amount, so the timing mismatch disappears and the payor deducts under the ordinary Section 267(a)(2) matching rule rather than the stricter cash-method requirement.³

Treaty benefits change this. If a treaty exempts the income from U.S. tax entirely or reduces the rate, the ECI exception is affected differently depending on the type of income:

Interest: the matching rule always applies, regardless of treaty benefits. Even a treaty rate of zero doesn’t accelerate the deduction.
Non-interest items fully exempt by treaty, such as business profits protected by a permanent establishment article: the matching rule does not apply, and the payor may deduct on accrual.
Non-interest items subject to a reduced treaty rate, such as royalties taxed below the statutory rate: the matching rule still applies. The deduction waits for payment.

The regulation draws the line where a partial U.S. tax remains at stake versus where the income drops out of U.S. tax entirely.³

Amounts Picked Up by a U.S. Shareholder of a CFC or PFIC

Section 267(a)(3)(B) handles payments to a controlled foreign corporation or a passive foreign investment company on their own terms. The payor can deduct an accrued amount before it’s paid, but only up to the amount a U.S. shareholder (using the Section 958(a) ownership rules) includes in gross income during the same taxable year.²

The idea is that if the payment feeds into Subpart F income and hits a U.S. shareholder’s return, the mismatch is cured to that extent. Whatever portion of the accrual doesn’t produce a current U.S. inclusion stays deferred until paid.

The same principle extends to GILTI. Treasury regulations under Section 951A provide that deductions are not deferred under Section 267(a)(3)(B) to the extent the item is taken into account in a U.S. shareholder’s GILTI inclusion. If the accrued amount flows through as CFC tested income and gets picked up in the GILTI calculation, the matching requirement is satisfied.⁶

The 8½-Month Safe Harbor

Treasury has statutory authority to exempt certain CFC and PFIC transactions from the matching rule, including transactions in the ordinary course of the payor’s predominant trade or business where payment happens within 8½ months of accrual. Short-cycle payables that settle quickly don’t produce the deferral abuse the statute targets.²

Payments to Related Tax-Exempt Entities

Section 267(a)(3) is not only a cross-border rule. It also reaches payments to related tax-exempt organizations under Section 501, because a tax-exempt payee generally doesn’t report the payment as gross income and the same mismatch appears. A taxable corporation accruing rent or management fees owed to an affiliated private foundation or pension trust must wait until cash moves before it deducts.⁴

The exception is when the payment is unrelated business taxable income (UBTI) for the payee. UBTI is subject to regular corporate tax, so the mismatch vanishes and accrual timing applies. Whether an item is UBTI is not always obvious. Rent from debt-financed property held by a tax-exempt organization is UBTI even though most rental income of a tax-exempt entity is not, so the payor needs to know how the affiliate is categorizing the income before assuming accrual treatment.

When the Deduction Finally Lands

Once matching applies, the compliance question is narrow: identify the taxable year in which the amount is paid. For a foreign payee, that’s the year the withholding rules would treat it as paid, which is usually the year the wire clears or the intercompany account is settled in cash.³

Because financial statements record the expense on accrual, this produces a book-tax difference. Corporations with total assets of $10 million or more reconcile the gap on Schedule M-3 of Form 1120.⁷ Smaller corporations use Schedule M-1. Either way, the return needs to show the accrual added back in the accrual year and deducted in the payment year, and the underlying schedule needs to support both moves.

Records that hold up on audit are the ones that prove cash actually moved: wire confirmations, bank statements, intercompany settlement documentation, and a running schedule tying each accrued liability to its later payment date. IRS examiners in this area go straight to the cash movement, not the journal entries.

What It Costs to Get Wrong

Taking the deduction in the accrual year when the matching rule required deferral creates an underpayment for that year. If the IRS treats the underpayment as negligence or disregard of the rules, it adds a 20% accuracy-related penalty under Section 6662.⁸ Negligence is defined broadly enough that a corporation with a foreign parent will have a hard time arguing it didn’t know about the rule.

Related-party reporting failures carry their own penalty. A 25% foreign-owned U.S. corporation (any foreign person owning at least 25% of voting power or value) must file Form 5472 for each foreign related party it had reportable transactions with, and reportable transactions include exactly the items that trigger Section 267(a)(3): interest, rents, royalties, and service fees.⁹ Failing to file, or failing to keep adequate records of the transactions, triggers a $25,000 penalty per year. If the failure continues more than 90 days after the IRS gives notice, another $25,000 accrues for each 30-day period the deficiency isn’t cured.¹⁰

Interest compounds on top of any underpayment from the original due date until it’s paid. For the first quarter of 2026, the underpayment rate is 7% for most corporations and 9% for large corporate underpayments; the second quarter rates drop to 6% and 8%.¹¹ A multi-year dispute over timing can generate a serious interest bill separate from any penalty.

1
Internal Revenue Service. Interest Expense Limitation on Related Foreign Party Loans Under IRC 267(a)(3)
2
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
3
eCFR. 26 CFR 1.267(a)-3 – Deduction of Amounts Owed to Related Foreign Persons
4
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers
5
GovInfo. 26 CFR 1.267(c)-1 – Constructive Ownership of Stock
6
Federal Register. Guidance Related to Section 951A (Global Intangible Low-Taxed Income)
7
Internal Revenue Service. Instructions for Schedule M-3 (Form 1120)
8
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
9
Internal Revenue Service. Instructions for Form 5472
10
Office of the Law Revision Counsel. 26 USC 6038A – Information With Respect to Certain Foreign-Owned Corporations
11
Internal Revenue Service. Quarterly Interest Rates