The IRS released final regulations (T.D. 9910) for the Base Erosion and Anti-Abuse Tax (BEAT) on Sept. 1 that clarify how to calculate the BEAT for groups of related taxpayers, modify the election to waive deductions, and provide additional guidance for partnerships.
These regulations (the 2020 final regulations) largely finalize proposed regulations issued on Dec. 2, 2019, (prior coverage of this topic, “IRS issues final and proposed BEAT regulations.” While the 2020 final regulations generally adopt the guidance provided in the 2019 proposed regulations, they contain some important revisions in response to taxpayer comments.
The modifications include rules addressing annualization when determining gross receipts and the base erosion percentage of the aggregate group, clarify how taxpayers should handle short taxable years, and also provide that the deemed tax year-end of a member joining or leaving an aggregate group occurs at the end of the day of the transaction. The 2020 final regulations also provide important clarifications to the BEAT waiver, indicating that a taxpayer must determine that it would be an applicable taxpayer for BEAT purposes if not for the BEAT waiver in order to waive deductions. They also reaffirm that the amount of waived deductions cannot be reduced on an amended return.
The final regulations can be applied retroactively, and affected taxpayers should evaluate opportunities to leverage beneficial changes, and thoroughly assess approaches that may run afoul of the intent of the regulations.
Background
The BEAT regime was enacted under Section 59A by the Tax Cuts and Jobs Act (TCJA). The BEAT imposes a minimum tax on certain domestic corporations with substantial gross receipts, and effectively acts to tax deductible payments to related foreign parties. It is primarily meant to target foreign-owned multinationals which have significant deductible related-party payments, but affects many large U.S. multinationals. 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 credits and other select general business credits will not offset the base erosion minimum tax.
Aggregate group rules
The 2019 final regulations provide guidance to taxpayers who are part of an aggregate group with different tax years. Specifically, the 2019 final regulations provide 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 2019 proposed regulations included proposed modifications to the 2019 final regulations on how a taxpayer determines its aggregate group for purposes of determining gross receipts and the base erosion percentage. Under the 2019 proposed regulations, a taxpayer with a short taxable year is required to use a “reasonable approach” to determine whether the taxpayer or its aggregate group satisfies the gross receipts test and base erosion percentage test, and also provides other rules to address specific circumstances impacting the aggregate group determination.
Determination of gross receipts and the base erosion percentage for short taxable years
The 2020 final regulations retain the rule in the 2019 proposed regulations permitting the use of a reasonable approach to determine whether a taxpayer’s aggregate group meets the gross receipts test and base erosion percentage test with respect to a short taxable year of the taxpayer. However, the 2020 final regulations clarify that a reasonable approach does not include an approach that excludes the gross receipts, base erosion tax benefits, and deductions of an aggregate group member in cases where the member’s taxable year does not end with or within a short taxable year of the taxpayer. The 2020 final regulations provide that a reasonable approach should not result in overcounting or undercounting and that any such result would constitute an unreasonable approach. The 2020 final regulations added several examples to provide guidance for taxpayers in determining whether an approach is reasonable.
Deemed closing of a taxable year
The 2019 proposed regulations further clarified the treatment of members that join or leave the aggregate group of a taxpayer. These regulations provided that a corporation joining or leaving had a deemed taxable year-end under the regulations immediately before joining or leaving the aggregate group.
The 2020 final regulations provide that when a corporation has a deemed taxable year-end before joining or leaving the aggregate group, the deemed taxable year-end is treated as occurring at the end of the day of the transaction. Thus, a new taxable year is deemed to begin at the beginning of the day after the transaction. Under the 2020 final regulations, a taxpayer determines items attributable to a deemed short taxable year by either deeming a close of the books, or by making a pro rata allocation without a closing of the books in the case of items other than extraordinary items. Special rules are provided for extraordinary items that generally require them to be included in the period in which they are taken into account.
Aggregate group members with different taxable years
The 2020 final regulations provide an annualization rule for the base erosion percentage test and gross receipts test to avoid overcounting when applying these tests. The 2020 final regulations provide that if a member of a taxpayer’s aggregate group has more than one taxable year that ends with or within the taxpayer’s taxable year, and the years comprise more than 12 months, then the member’s gross receipts, base erosion tax benefits and deductions for those years are annualized to 12 months for purposes of determining the gross receipts and base erosion percentage of the taxpayer’s aggregate group. The 2020 final regulations also adopt a corresponding rule to address short taxable years of members. The 2020 final regulations also added an anti-abuse rule related to members with differing tax years, that targets transactions that result in the exclusion of gross receipts or base erosion percentage items of a taxpayer or a member of the taxpayer’s aggregate group that are undertaken with a principal purpose of avoiding applicable taxpayer status.
BEAT waiver election
The 2019 proposed regulations provided taxpayers the option to waive deductions that would otherwise be base erosion payments so that they are not taken into account for purposes of the BEAT. The forgone deductions under the waiver are not 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. The 2019 proposed regulations provided specific requirements related to the time and manner for making the election to waive deductions, including a detailed description of the item or property to which the deduction relates and sufficient information to identify that item or property on the taxpayer’s books and records. The 2020 final regulations finalize these rules, but make certain modifications, including eliminating a requirement to provide a “detailed” description of the item or property to which the deduction relates.
The 2020 final regulations clarify that in order to make or increase the BEAT waiver election, the taxpayer must determine that the taxpayer would be an applicable taxpayer for BEAT purposes without the BEAT waiver election (e.g., a controlled foreign corporation that does not have effectively connected income cannot make the election). The 2020 final regulations also provide that only a partner and not a partnership can make a BEAT waiver election. In reference to consolidated groups, the 2020 final regulations clarify that waived deductions attributable to a consolidated group member are treated as noncapital, nondeductible expenses that decrease the tax basis in the member’s stock for purposes of the stock basis rules.
Grant Thornton Insight:
While the 2020 final regulations rejected numerous requests for flexibility to allow taxpayers to decrease the amount of deductions waived by filing an amended return or during an examination, the election remains potentially valuable. The original waiver election can be made on an originally filed or amended federal income tax return.
Application of the BEAT to partnerships
The 2019 final regulations provide an exception whereby amounts paid or accrued to a foreign related party that are subject to tax as effectively connected income (ECI) do not result in a base erosion payment. The 2020 final regulations expand the ECI exception to apply to certain partnership transactions. Specifically, the ECI exception also now applies to transactions where the taxpayer is treated as making a base erosion payment as a result of a deemed transaction with a foreign related party, and where the foreign related party is subject to U.S. federal income tax on allocations of income from a partnership.
Anti-abuse rule
The 2019 final regulations provide an exception to the definition of a base erosion payment for certain amounts transferred to or exchanged with a foreign related party in a transaction described in Sections 332, 351, 355, and 368, referred to as the “specified nonrecognition transaction exception.” However, the 2019 final regulations proposed an anti-abuse rule providing that if a transaction, plan, or arrangement has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a specified nonrecognition transaction, the specified nonrecognition transaction exception will not apply to the transaction. The 2020 final regulations modify the anti-abuse rule to provide that when the anti-abuse rule applies, its effect is to turn off the application of the specified nonrecognition transaction exception only to the extent of a basis step-up amount. The 2020 final regulations also clarify that a transaction, plan, or arrangement with a principal purpose of increasing the adjusted basis of property must also have a connection to the acquisition of the property in a specified nonrecognition transaction.
Applicability dates
The 2020 final regulations generally apply to tax years beginning on or after the day the regulations are published in the Federal Register. The rules related to partnership allocation of income and certain partnership anti-abuse rules apply to taxable years ending on or after Dec. 2, 2019. Taxpayers also may choose to apply the 2020 final regulations retroactively, provided they are applied in their entirety, for tax years beginning after Dec. 31, 2017. Once applied, taxpayers must continue to apply these regulations in their entirety for all subsequent tax years. Alternatively, taxpayers may apply only the rules relating to the BEAT waiver election for taxable years beginning after Dec. 31, 2017, and before their applicability date, provided that once applied, taxpayers continue to apply such rules in their entirety for all subsequent taxable years.
In addition, taxpayers may choose to rely on the 2019 proposed regulations in their entirety for taxable years beginning after Dec. 31, 2017, and before the date of publication of the 2020 final regulations in the Federal Register.
Next steps
The 2020 final regulations expand on previously provided guidance under Section 59A and clarify many areas of concern expressed by taxpayers. These rules continue to have broad applicability impacting large U.S.-owned multinationals. As a result, applicable taxpayers should assess the impact of the final regulations, evaluate opportunities to use the beneficial changes, and carefully analyze approaches that may run afoul of the intent of the regulations or produce a negative result. These rules are complex, so taxpayers should closely analyze the application and mechanics of the rules.
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