The IRS issued final (T.D. 9885) and proposed (REG-112607-19) regulations addressing the Base Erosion and Anti-Abuse Tax (BEAT) on Dec. 2.
The final regulations generally adopt proposed regulations (REG-104259-18) released in December 2018, which provided initial guidance on the BEAT and resolved some fundamental questions. The final regulations contain some modifications in response to taxpayer comments, including clarifications on the definition of “applicable taxpayer” for purposes of the BEAT, the computation of modified taxable income (MTI) and the definition of base-erosion tax benefits. In addition, they provide guidance on the application of the BEAT to insurance companies, banks, registered securities dealers, partnerships, and consolidated groups.
The new proposed regulations provide further guidance with respect to several areas including, the determination of a taxpayer’s aggregate group, an election to waive deductions, and the application of BEAT to partnerships.
Background
The BEAT regime was enacted under Section 59A by the Tax Cuts and Jobs Act (TCJA). The BEAT, which taxes deductible payments to related foreign parties, primarily targets foreign-owned multinationals which have significant deductible related-party payments, but also affects many large U.S. multinationals. It generally imposes a minimum tax on certain domestic corporations with substantial gross receipts. It applies to domestic corporations other than S corporations, real estate investment trusts (REIT), and regulated investment companies (RIC). The corporation or the aggregate group of the corporation must have at least $500 million or more in average annual gross receipts over the preceding three-year period and have a ratio of base erosion deductions compared to total deductions of 3% or higher (2% or higher for certain banks and securities dealers) for the taxable year.
The BEAT tax is phased in at a rate of 5% for tax years beginning in 2018, 10% for tax years beginning in 2019 through 2025, and 12.5% for tax years beginning after Dec. 31, 2025. Each rate is increased by 1% for certain banks and securities dealers. The BEAT amount is the excess of 5% (or the applicable rate as described above) of the taxpayer’s “modified taxable income” over the regular tax liability reduced for certain credits (including the foreign tax credit).
For taxable years beginning before Jan. 1, 2026, the calculation of a taxpayer’s base erosion minimum tax amount will consider the R&D credit plus a portion of certain applicable general business credits. For taxable years beginning after Dec. 31, 2025, R&D and other select general business credits will not offset the base erosion minimum tax.
Final regulations
Nonrecognition transactions
The final regulations favorably modify the 2018 proposed regulations to exclude from the definition of a base erosion payment, any payment that is transferred to, or exchanged with, a foreign related party as part of a nonrecognition transaction under Sections 332, 351, 355, or 368 (does not apply to amounts treated as "other property" in the final regulations). Other property for these purposes is defined under Sections 351(b), 356(a)(1)(B), and 361(b), including liabilities described in Section 357(b), and gain recognized only to the extent of liabilities under section 357(c).
The final regulations also address Section 301 distributions, and clarify that they are not base erosion payments. The IRS expressed concern that the exclusion of nonrecognition transactions could lead to inappropriate results in some situations. As a result, the final regulations also include an anti-abuse measure relating to certain nonrecognition transactions.
GILTI/Subpart F inclusions
The IRS retained the approach of the 2018 proposed regulations and did not adopt an exception for Subpart F, GILTI, and PFIC inclusions. Instead, the final regulations offer a policy rationale in the preamble to explain why no exception is provided.
services cost method
The final regulations retain the general approach from the 2018 proposed regulations and continue to provide that the SCM exception is available for the cost portion of a payment that otherwise meets the requirements for the SCM exception. In addition, the final regulations include additional detail on the documentation required to satisfy this requirement. The IRS discussed the policy considerations for expanding the SCM exception but determined it would be inconsistent with the parameters that Congress set forth in Section 59A(d)(5).
Loss transactions
The final regulations clarify the definition of a base erosion payment to exclude losses recognized on the sale or exchange of property by a taxpayer to a foreign related party. They provide that the term “base erosion payment” does not include the amount of built-in loss because that built-in loss is unrelated to the payment made to the foreign related party. Further, the final regulations explain that to the extent that a transfer of built-in-loss property results in a deductible payment to a foreign related party that is a base erosion payment, the amount of the base erosion payment is limited to the fair market value of that property.
Aggregate group; members with different taxable years
The final regulations provide guidance to taxpayers who are part of an aggregate group with different tax years. The final regulations adopt the approach that the determination of gross receipts and the base erosion percentage of an aggregate group is made by reference to the taxpayer’s taxable year, and the tax year of each member of the aggregate group that ends “with or within” the applicable taxpayer’s taxable year. The final regulations also clarify that the rule applies regardless of whether the taxable year of the member begins before Jan. 1, 2018.
Aggregate group, transactions between members
The final regulations confirm that a transaction between parties is disregarded for purposes of Section 59A for determining the gross receipts and base erosion percentage of an aggregate group if both parties were members of the aggregate group at the time of the transaction. This rules applies without regard to whether the parties were members of the aggregate group on the last day of the taxpayer’s taxable year.
Interest expense allocable to effectively connected income (ECI)
With respect to interest expense allocable to a foreign corporation’s ECI, the IRS acknowledged that the rules for determining the portion of U.S. branch interest paid to foreign related parties should be consistent, regardless of whether taxpayers apply the method described in Treas. Reg. Sec. 1.882-5(b) through (d) or Treas. Reg. Sec. 1.882-5(e). The final regulations simplify the elections for determining the amount of U.S. branch interest treated as paid to foreign related parties, including computing the worldwide ratio by reference to interest expense rather than worldwide liabilities (defined as the “worldwide interest ratio”). They provide that determination of the amount of a U.S. branch’s interest expense treated as a base erosion payment should be based on the foreign corporation’s worldwide interest ratio.
Division of revenues from global services
The final regulations do not adopt an exception from the term “base erosion payment” for transactions that are priced based on the profit split or similar transfer pricing method used for purposes of Section 482, including allocations with respect to global dealing operations. Notwithstanding taxpayer requests, the final regulations rejected the idea of looking through these transactions and said that the proper characterization depends on the underlying facts and the relationships between the parties. Furthermore, the final regulations do not adopt a general exception to the definition of a base erosion payment in situations when the foreign related payee also makes payments to unrelated persons.
Other provisions
Among many other issues, the final regulations also address the following:
- Blending – The final regulations provide that taxpayers with fiscal years beginning in calendar year 2018 and ending in 2019 cannot use a blended BEAT rate. The rate for any tax year beginning in calendar year 2018 is 5%.
- Modified taxable income (MTI) – The final regulations retain the “add-back” method for computing MTI. This method determines modified taxable income without regard to both the base erosion tax benefits and the base erosion percentage of net operating loss deductions.
- AMT credits – The final regulations provide that AMT credits, like overpayment of taxes and taxes withheld at source, do not reduce adjusted regular tax liability for purposes of Section 59A.
- De minimis banking and securities dealer activities – The final regulations revise Treas. Reg. Sec. 1.59A-5(c)(2) to provide that the additional 1% add-on to the BEAT rate will not apply to a taxpayer that is part of an affiliated group with de minimis banking and securities dealer activities.
- Cost of goods sold – The final regulations retains the definition of “gross receipts” in the 2018 proposed regulations, and maintains that gross receipts are not reduced by cost of goods sold.
- Anti-abuse rules and examples – The final regulations clarify the “principal purpose” standard and treatment of ordinary course transactions by adding several new examples that illustrate abusive or nonabusive transactions.
Applicability dates
In general, the final regulations are applicable for tax years ending on or after Dec. 17, 2018. Taxpayers also may apply the final regulations in their entirety for tax years ending before Dec. 17, 2018, so long as they are applied consistently.
Grant Thornton Insight:
The final regulations do offer some relief in a number of areas, but for payments to affiliates who subsequently pay third parties, it is important to focus on documentation of SCM and the revised non-recognition rules. Consider reviewing 2018 tax returns to ascertain if an amended tax return would be beneficial. As the BEAT tax rate is increasing, more taxpayers will be at risk of becoming subject to BEAT, thereby making modeling and planning more important.
New proposed regulations
Election to waive deductions
The newly proposed regulations provide taxpayers the option to forgo base erosion payment deductions so they are not taken into account for purposes of the BEAT. Those foregone deductions will not be treated as a base erosion tax benefit if the taxpayer waives the deduction for all U.S. federal income tax purposes and follows specified procedures. If the taxpayer waives a deduction, the taxpayer cannot claim the deduction for any other purpose. A taxpayer may make the election to waive deductions on its original filed federal income tax return, by an amended return, or during the course of an examination of the taxpayer’s income tax return for the relevant tax year pursuant to procedures prescribed by the IRS Commissioner. The election to waive deductions should be made on an annual basis.
Aggregate groups
The proposed regulations include modifications to the provision in the final regulations relating to how a taxpayer determines its aggregate group for purposes of determining gross receipts and the base erosion percentage. The proposed regulations provide guidance regarding certain applications of the aggregate group rules and request comments regarding these rules in light of the with-or-within method. A taxpayer determines its gross receipts and the base erosion percentage of the taxpayer’s aggregate group on the basis of the taxpayer’s taxable year and the taxable year of each member of its aggregate group that ends with or within the applicable taxpayer’s taxable year. Under the new proposed regulations, a taxpayer with a short taxable year must use a “reasonable approach” to determine the base erosion percentage of its aggregate group and whether the taxpayer or its aggregate group satisfies the gross receipts test and base erosion percentage of Section 59A. The new proposed regulations also provide guidance that clarifies the treatment of members that join or leave the aggregate group of a taxpayer, and that the gross receipts are not double-counted by application of the predecessor rule.
Application of BEAT to partnerships
The new proposed regulations clarify a number of areas with regards to the application of the BEAT to partners and partnerships. Specifically, the new proposed regulations include a provision addressing allocations of income by a partnership as well as new anti-abuse rules. The new proposed regulations state that the IRS is considering additional partnership guidance and request comments on the treatment of a contribution by a foreign person to a partnership engaged in a U.S. trade or business, as well as transfers of partnership interests by a foreign person and transfers of property by the partnership with a foreign person as a partner to a related U.S. person.
Proposed applicability date
The new proposed regulations are proposed to be applicable to tax years beginning on or after the date the regulations are filed as final regulations in the Federal Register. Taxpayers may rely on the new proposed regulations in their entirety for taxable years beginning after Dec. 31, 2017, and before the final regulations are finalized.
Grant Thornton Insight:
The proposed regulations offer significant planning opportunities, allowing taxpayers to elect to waive deductions which could result in either eliminating or reducing the BEAT liability. The proposed regulations are retroactively applicable, meaning taxpayers may apply the proposed regulations for tax years beginning after Dec. 31, 2017, including amending previously filed returns if necessary.
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