December 16, 2018 Proposed regulations provide guidance on the base-erosion and anti-abuse tax under Section 59A On December 13, 2018, the United States Treasury Department (Treasury) and Internal Revenue Service issued proposed regulations (REG-104529-18) under Section 59A (Proposed Regulations), providing guidance on the application of the base erosion and anti-abuse tax (BEAT). The Proposed Regulations include provisions addressing:
The Proposed Regulations would apply to tax years beginning after December 31, 2017. Until the regulations are finalized, however, taxpayers may rely on the proposed regulations if they and all related parties consistently apply the regulations to all tax years ending before the date on which final regulation are published. Background In general, the BEAT applies to a corporation (other than a RIC, REIT, or S corporation) that is subject to US net income tax and has (i) average annual gross receipts of at least $500 million for the three-year period ending with the preceding tax year (the gross receipts test), and (ii) a "base erosion percentage" of 3% (2% for a taxpayer that is a member of an affiliated group with a domestic bank or registered securities dealer) or more (the base erosion percentage test). A corporation subject to the BEAT is an "applicable taxpayer." The taxpayer and certain corporations with whom the taxpayer is considered as part of the same "controlled group of corporations" (determined under the rules of Sections 52 and 1563 with regard to the inclusion of foreign corporations) are aggregated as one person (the aggregation rules) for purposes of applying the gross receipts and base erosion tests to determine whether the taxpayer is an applicable taxpayer. Generally, under the aggregation rules, corporations that are part of one or more chains of corporations connected through stock ownership of more than 50% (by vote or value) under a common parent are aggregated as one person (the aggregate group). The only gross receipts of a foreign corporation taken into account for determining the gross receipts of the aggregate group are those amounts taken into account in determining income that is effectively connected with the conduct of a US trade or business (ECI). Base erosion minimum tax amount In addition to any other income tax, an applicable taxpayer must pay a "base erosion minimum tax amount" equal to the excess (if any) of 10% (5% for tax years beginning in calendar-year 2018)1 of its "modified taxable income" over an adjusted regular tax liability amount for the tax year. The adjusted regular tax liability amount is the applicable taxpayer's regular tax liability amount reduced (but not below zero) by all credits (including foreign tax credits) other than the research credit and 80% of certain other Section 38 credits (e.g., the renewable electricity production credit).2 An applicable taxpayer that is a member of an affiliated group that includes a bank or a registered securities dealer is subject to a rate that is 1% greater than the rates previously described. Modified taxable income, base erosion payments, and base erosion tax benefits An applicable taxpayer's modified taxable income equals its taxable income for the year, determined without regard to (i) any deductions allowed (or certain reductions to gross receipts) (a base erosion tax benefit) with respect to a "base erosion payment," and (ii) the base erosion percentage of any NOL deduction allowed under Section 172. Base erosion payments consist of (i) any amount paid or accrued by the taxpayer to a "foreign related party"3 and for which a deduction is allowed; (ii) any amount paid or accrued by the taxpayer to a foreign related party in connection with the acquisition of depreciable (or amortizable) property; (iii) certain reinsurance payments to a foreign related party, and (iv) any amount paid or accrued to an entity that becomes a "surrogate foreign corporation" after November 9, 2017, or any amount paid or accrued to foreign person that is a member of the same expanded affiliated group as the surrogate foreign corporation. Base erosion tax benefits are defined by reference to base erosion payments. For example, base erosion tax benefits include (i) a deduction allowed for any amount paid or accrued to a foreign related party (e.g., an amount of interest deductible under Section 163); and (ii) a depreciation (or amortization) deduction allowed for the acquired depreciable (or amortizable) property. Excluded from base erosion payments is any amount paid or accrued by a taxpayer for services if (i) those services satisfy the requirements for using the services cost method (SCM) as described in Treas. Reg. Section 1.482-9 (without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure), and (ii) that amount is the total services cost with no markup component (the SCM exception). Any "qualified derivative payments" (generally unrealized loss amounts on derivatives that are included annually in certain taxpayers' income as ordinary) made by the taxpayer are also excluded from being a base erosion payment. For a base erosion payment that is "fixed, determinable, annual or periodical" (FDAP) income subject to 30% gross basis withholding under Sections 1441 and 1442, the amount of the base erosion tax benefit with respect to the payment is reduced by an amount proportionate to the actual rate of tax imposed on the income (e.g., the actual rate may be the reduced rate (or exemption) provided by an applicable US tax treaty) to 30%. Thus, for example, the deduction allowed for a FDAP royalty payment to a foreign related party that is subject to full 30% withholding tax will not be taken into account as a base erosion tax benefit. Base erosion percentage The base erosion percentage for any tax year is generally the aggregate amount of base erosion tax benefits for the year (the numerator) divided by the aggregate deductions for the year (including base erosion tax benefits) but excluding deductions allowed under Sections 172, 245A or 250, and certain other deductions that are not base eroding payments (e.g., deductions on qualified derivative payments to foreign related parties, payments qualifying for the SCM exception, and Section 988 exchange loss (discussed later)). Reporting requirements In connection with the enactment of BEAT under Section 59A, the TCJA added information reporting obligations concerning the BEAT and payments subject to BEAT under Sections 6038A for domestic corporations that are 25% or more foreign-owned and Section 6038C for foreign corporations engaged in a US trade or business. Detailed discussion of Proposed Regulations Prop. Reg. Sections 1.59A-1 and -2: Determining an applicable taxpayer For purposes of determining whether a taxpayer is an applicable taxpayer, the Proposed Regulations would clarify that a taxpayer that is a member of an aggregate group determines its gross receipts and base erosion percentage on the basis of the aggregate group as of the end of the taxpayer's tax year. A consolidated group would generally be treated as a single taxpayer by the Proposed Regulations for purposes of determining whether the group is an applicable taxpayer. The Proposed Regulations provide rules for determining an applicable taxpayer under the aggregation rules. The terms of the aggregation rules under the statute are not entirely clear in addressing whether payments between members of the same aggregate group are recognized for purposes of applying the gross receipts and base erosion percentage tests. For example, for a foreign parent (with no US trade or business) that wholly owns two US subsidiaries, it is not clear under the statute whether royalty payments made by the US subsidiaries to the foreign parent (which are base erosion payments) are taken into account by the aggregate group (i.e., because the foreign parent and US subsidiaries are to be treated as one person under the aggregation rules) in determining the group's base erosion percentage. The Proposed Regulations would clarify the application of the aggregation rules to define an aggregate group and determine the members of that group in the following manner: (1) the controlled group of corporations would be identified under the rules of Sections 52 and 1563 (regarding the inclusion of foreign corporations), and (2) once the controlled group of corporations is determined, all foreign corporations, except those with regard to income that is (or treated as) ECI, would be excluded from the aggregate group. As a result, under the aggregation rules, the aggregate group would consist of domestic corporations (excluding RICs, REITs and S corporations) and foreign corporations, to the extent the foreign corporation has ECI (or net taxable income under an applicable US tax treaty). The Proposed Regulations would exclude transactions occurring between members of an aggregate group for purposes of determining the base erosion percentage and gross receipts of the aggregate group. Moreover, the regulations specify that certain items are not taken into account in the denominator for purposes of the base erosion percentage.4 Consistent with the general treatment of a partnership under the Proposed Regulations as an aggregate for purposes of applying the BEAT provisions (discussed later), if a member of an aggregate group owns an interest in a partnership, the group would include its share (which would be proportionate to its distributive share of items of gross income) of the gross receipts of the partnership in its gross receipts. For purposes of computing the amount of gross receipts of an aggregate group, the Proposed Regulations provide rules generally consistent with the rules in determining gross receipts under Section 448. Detailed rules address how to determine gross receipts when members of the aggregate group have different tax years. De minimis exception for aggregate groups with banking and registered securities dealers A 2% base erosion percentage threshold applies to any taxpayer that is a member of an affiliated group that includes a domestic bank or registered securities dealer. The Proposed Regulations provide a helpful exception to this general rule for an aggregate group with total gross receipts attributable to a bank or registered securities dealer of less than 2% of the total gross receipts. If the 2% threshold is met, the aggregate would be treated as not having a bank or registered securities dealer. Prop. Reg. Section 1.59A-3: Base erosion payments and base erosion tax benefits The Proposed Regulations would apply US tax principles in determining whether an amount paid or accrued by the taxpayer to a foreign related party is considered a base erosion payment. For example, the Proposed Regulations do not address whether a royalty payment is deductible under Section 162 (and potentially a base erosion payment) or a cost capitalized in inventory under Sections 471 and 263A that would result in a reduction in gross income under Section 61 (and generally not considered a base erosion payment). Moreover, the Preamble emphasizes that the Proposed Regulations do not establish any rules specific to Section 59A for determining when a payment is treated as deductible (and potentially a base erosion payment), or as an amount other than deductible (and therefore not a base erosion payment) because it is beneficially owned by another person under principal-agent, conduit or assignment of income principles. The Proposed Regulations similarly confirm that the amount of any base erosion payment is generally determined on a gross basis, and would not permit the netting of amounts owed between the taxpayer and foreign related party, regardless of any contractual or legal right to do so (e.g., an agreement covering reciprocal payments between the parties that may be settled on a net basis). A notable exception to this gross principle applies to taxpayers with derivative, security and other financial positions that are marked to market annually. The Proposed Regulations are explicit that all income, gain, loss and deductions must be net into one annual gain or loss for the position, even if there is a technical basis for segregating components of the position into gross amounts. Cash and non-cash consideration treated similarly The Proposed Regulations also provide that a payment or accrual by the taxpayer to a foreign related party may be a base erosion payment, regardless of whether the payment is in cash or non-cash consideration (e.g., property, stock or the assumption of a liability). Accordingly, a base erosion payment may occur in the context of a domestic corporation's acquisition of depreciable assets from a foreign related party in exchange for shares of the taxpayer in a non-recognition transaction (e.g., a Section 351 exchange, a Section 332 liquidation or a Section 368 reorganization). As discussed in the Preamble, however, no base erosion payment would arise when a taxpayer that owns stock in a foreign related party receives depreciable property from the foreign related party in a Section 301 distribution because the taxpayer does not provide consideration for the property. Further, a base erosion payment includes a payment to a foreign related party resulting in a recognized loss (e.g., a loss recognized on the transfer of property to a foreign related party). Exceptions to base erosion payments SCM exception As discussed, the SCM exception as defined in the statute excludes from base erosion payments amounts paid or accrued to a foreign related party for services eligible for the SCM without regard to the business judgment rule (defined later), and that amount constitutes the total services cost with no markup component. The SCM allows for certain services to be charged at cost with no markup. The SCM is only available for "covered services," which are generally back-office or administrative services or low-margin covered services. Covered services do not include services such as manufacturing, research and development, reselling and construction. Furthermore, the SCM is not available for services that contribute significantly to the fundamental risks of business success or failure (business judgment rule). Taxpayers may elect to apply SCM for eligible services, but are not required to do so. For example, many foreign jurisdictions do not allow any outbound services to be compensated at cost. These types of services (i.e., services performed for a US company by a foreign affiliate, which often include a markup) fall within the ambit of Section 59A. The Proposed Regulations would helpfully clarify that the SCM exception, with the modifications to the business risk rule contained in the statutory language, is available if there is a markup (and if other requirements are satisfied), but that the portion of any payment that exceeds the total cost of services — the markup component — is not eligible for the SCM exception and is a base erosion payment. The Proposed Regulations would not require the maintenance of separate accounts for the cost and the markup, but would require that taxpayers maintain adequate books and records to permit verification of the amount paid for services, the total services costs incurred by the service rendered and the allocation and apportionment of costs to services in accordance with Treas. Reg. Section 1.482-9(k). Furthermore, taxpayers would have to include a calculation of the amount of the markup paid for the services. Exception for qualified derivative payments As discussed, a qualified derivative payment (QDP) is excluded from being considered a base erosion payment. To qualify, the payment must be made under a derivative, the taxpayer must mark the derivative to market and recognize ordinary income, gain or loss with respect to it, the payment must not otherwise be a base erosion payment (or allocable to a non-derivative component), and certain reporting requirements must be satisfied. The Proposed Regulations under Prop. Reg. Section 1.59A-6 provide specific guidance on qualified derivative payments, and in particular would exclude a securities lending transaction, a sale-repurchase transaction or any substantially similar transaction from the definition of derivative, with the result that payments on such instruments to a foreign related party would be base erosion payments. The reasons, according to the Preamble, are: (1) a sale-repurchase transaction satisfying certain conditions is treated as a secured loan, and (2) Section 59A(h)(3) provides that a QDP does not include any payment that would be a base erosion payment if it were not made pursuant to a derivative, such as interest on debt. The Preamble further explains that, because securities lending transactions are similar to a sale-repurchase transaction, securities lending transactions also are not derivatives. Exception for ECI The Proposed Regulations would exclude from base erosion payments those amounts paid or accrued to a foreign related party that is (or is treated as) ECI (or taken into account in determining net taxable income under an applicable US income tax treaty) (the ECI Exception). The Preamble explains that those amounts are subject to US tax on a net basis in substantially the same manner as amounts paid to a US resident or domestic corporation. The Proposed Regulations would not, however, extend the exception to cover payments that constitute subpart F income or tested income of a CFC, even though these amounts may be included in the gross income of a US shareholder as a subpart F income or GILTI inclusion. Exception for Section 988 losses Exchange losses on Section 988 transactions would not be a base erosion payment under the Proposed Regulations, and accordingly would be excluded from the numerator and the denominator of the base erosion percentage. Exchange gains from Section 988 transactions would, however, be included in gross receipts for purposes of the gross receipts test. Exception for payments on total loss absorbing capacity securities Amounts paid or accrued to a foreign related person for a total loss absorbing capacity (TLAC) would not be treated as a base erosion payment. TLAC securities are securities that the Federal Reserve requires to be issued by certain global systematically important banks. The TLAC exception would apply only to securities required by the Federal Reserve. Exception for amounts paid or accrued in tax years beginning before January 1, 2018 Section 59A applies only to base erosion payments paid or accrued in tax years beginning after December 31, 2017. Consistent with the effective date of the provision, the Proposed Regulations confirm that a depreciation (or amortization) deduction allowed in tax years beginning after December 31, 2017, for depreciable (or amortizable) property acquired from a foreign related party before that tax year is not a base erosion tax benefit. Exception for disallowed business interest under prior Section 163(j) In Notice 2018-28, Treasury indicated that proposed regulations under Section 59A would treat interest expense disallowed under prior Section 163(j) that is carried forward to the first tax year beginning after December 31, 2018, in the same manner as if the interest amount were actually paid in that year for purposes of applying BEAT. The Proposed Regulations would reverse that position, and instead exclude from base erosion payments any disallowed interest under prior Section 163(j) that resulted from a payment or accrual to a foreign related party and that is carried forward. Specific rules for determining the base erosion payment of a US branch The Proposed Regulations provide rules for determining the amount of interest expense of a foreign corporation allocable to ECI under Reg. Section 1.882-5 that constitutes a base erosion payment. Interest on direct allocations and on US-booked liabilities paid or accrued to a foreign related party would be a base erosion payment. If US-booked liabilities exceed US-connected liabilities, a foreign corporation computing its interest expense under this method would have to apply a scaling ratio to all of its interest expense on a pro-rata basis to determine the amount that is a base erosion payment. Interest on excess US-connected liabilities may also be a base erosion payment if the foreign corporation has liabilities with a foreign related party. Other deductions properly allocated and apportioned to effectively connected gross income of the foreign corporation under Reg. Section 1.882-4 would constitute base erosion payments to the extent that those deductions were paid or accrued to a foreign related party. For a foreign corporation engaged in a US trade or business that acquires depreciable or amortizable property from a foreign related party, the amount paid or accrued by that foreign corporation would be a base erosion payment to the extent the property is used, or held for use, in the conduct of the US trade or business. The Proposed Regulations also provide specific rules on internal dealings under certain income tax treaties. In particular, if under a treaty, a foreign corporation determines the business profits attributable to a permanent establishment (PE) based on the assets used, risks assumed and functions performed by the PE, then any deduction attributable to any amount paid or accrued by the PE to the foreign corporation's home office or to another branch of the foreign corporation (referred to as "internal dealings") would be treated as a base erosion payment. Coordination of Section 59A and Section 163(j) Consistent with Section 59A(c)(3), the Proposed Regulations provide for BEAT purposes that, when a corporation has business interest expense paid or accrued to both unrelated parties and related parties, the amount of business interest expense allowed under Section 163(j) is treated first paid to related parties (proportionately between foreign and domestic related parties) and then as paid to unrelated parties. Conversely, the amount of a disallowed business interest expense carryforward would be treated first as business interest expense paid to unrelated parties, and then as business interest expense paid to related parties (proportionately between foreign and domestic related-party business interest expense). Consistent with the ordering rule in the proposed Section 163(j) regulations, the Proposed Regulations would allocate business interest expense deductions first to business interest expense incurred in the current year and then to business interest expense carryforwards from prior years (starting with the earliest year) for BEAT purposes. Prop. Reg. Section 1.59A-4: Modified taxable income While applicable taxpayer status is determined on the basis of the aggregate group, the Proposed Regulations confirm that computing modified taxable income (MTI) and the base erosion minimum tax amount (BEMTA) is done on a taxpayer-by-taxpayer basis (treating a consolidated group as a single taxpayer for these purposes). MTI would be computed using an add-back approach, rather than a recomputation method (e.g., as in the case of the repealed alternative minimum tax). MTI is defined in the Proposed Regulations as a taxpayer's taxable income, plus the sum of: (i) the amount of any base erosion tax benefit, and (ii) the base erosion percentage of any NOL deduction allowed to the taxpayer under Section 172 for the tax year. The Preamble clarifies that a taxpayer with an excess of deductions over gross income in a given tax year (computed without regard to the NOL deduction from NOL carrybacks or carryforwards) uses the corresponding negative amount as its starting point for computing MTI. If, however, a taxpayer has an NOL deduction from NOL carrybacks or carryforwards, the Proposed Regulations would require that the NOL allowed cannot exceed taxable income (before taking into account the NOL deduction) for purposes of the starting point for computing MTI. In other words, the Proposed Regulations would prohibit a negative starting point for computing MTI due to an NOL deduction from an NOL carryback or carryforward. This provision appears at odds with the statute, which uses taxable income (which reflects the entire amount of a NOL carryforward or carryback as a deduction) as the starting point for computing modified taxable income. Unlike Section 163(j), Section 59A does not authorize Treasury to specify adjustments to taxable income for determining modified taxable income other than those specified in the statute. For purposes of computing the base erosion percentage of any NOL deduction that is added back to taxable income, the base erosion percentage for the tax year that the NOL arose, rather than the base erosion percentage for the year the NOL is utilized, would be the percentage applied. For an NOL that arose in a tax year beginning before January 1, 2018, the base erosion percentage applied for that tax year would be zero. If the taxpayer is a member of an aggregate group, the base erosion percentage of the aggregate group would be used to compute MTI instead of the base erosion percentage of the taxpayer on a standalone basis. Finally, the amount of the NOL deduction that is taken into account for purposes of the add back would be the same amount used to determine the starting point for computing MTI, discussed previously. The following is an example provided by the Proposed Regulations (in abbreviated and edited form) of how the proposed rules for computing MTI would apply. Facts: A domestic corporation (DC) is an applicable taxpayer that has a calendar tax year. In 2020, DC has gross income of $100x, a deduction of $80x that is not a base erosion tax benefit, and a deduction of $70x that is a base erosion tax benefit. In addition, DC has a NOL carryforward to 2020 of $400x that arose in 2016. Analysis: DC's starting point for computing MTI is $(50x), computed as gross income of $100x, less a deduction of $80x (non-base erosion tax benefit) and a deduction of $70x (base erosion tax benefit). DC's starting point for computing MTI does not take into account the $400x NOL carryforward because the allowable deductions for 2020, not counting the NOL deduction, exceed gross income for 2020. DC's MTI for 2020 is $20x, computed as $(50x) + $70x base erosion tax benefit. If instead DC had gross income of $500x in 2020, its starting point for computing MTI is $0x: $500x of gross income, less a deduction of $80x (non-base erosion tax benefit), a deduction of $70x (base erosion tax benefit), and an NOL deduction of $350x (which is the amount of taxable income before taking into account the NOL deduction). DC's MTI in this case would be $70x, computed as $0x +$70x base erosion tax benefit. Because the $350x NOL deduction relates to an NOL in a tax year before January 1, 2018, taxable income is not increased as a result of the NOL deduction because the base erosion percentage is zero. Finally, the Proposed Regulations would not take into account the limitation in Section 860E(a)(1) (relating to certain interests in real estate mortgage investment conduits) for purposes of determining the taxable income that is used to compute MTI. Prop. Reg. Section 1.59A-5: Base erosion minimum tax amount Generally, the Proposed Regulations are consistent with the statute for the computation of the BEMTA (as discussed previously), except that credits for overpayment of taxes (Section 33) and for taxes withheld at source (Section 37) would not be subtracted from a taxpayer's regular tax liability in determining the taxpayer's adjusted regular tax liability. The Preamble states this rule is to prevent an inappropriate understatement of a taxpayer's adjusted regular tax liability. The exclusion of Section 33 and Section 37 credits in computing a taxpayer's adjusted regular tax liability would apply to all tax years beginning after December 31, 2017. Prop. Reg. Section 1.59A-7: Application of BEAT to partnerships The Proposed Regulations would generally apply an aggregate approach to partnerships. Thus, in determining whether payments to or from a partnership (whether domestic or foreign) are base erosion payments, payments would be treated as having been paid to, or paid by, the member partners in accordance with the partners' distributive share of the partnership's income or expense as determined under Section 704. There is similar aggregate treatment for foreign corporations that are partners in a partnership that generates income that is ECI or income that is taken into account by the foreign corporate partners under an income tax treaty. Example: Foreign parent (FP) wholly owns US subsidiary (US). FP also owns a 50% interest in a US partnership. An unrelated third party owns the remaining interest in the partnership. The partnership's items of income are allocated 50/50 to its member partners. US makes a $100 deductible royalty payment to the partnership. Under the Proposed Regulations, $50 of the royalty payment made is treated as paid or accrued to FP and accordingly considered a base erosion payment. There is an exception to the aggregate treatment of partnerships when a partner owns a small interest in a partnership. If the exception applies, in determining a partner's amount of base erosion tax benefits, a partner does not take into account its distributive share of any partnership amount of base erosion tax benefits for the tax year. The exception applies if (i) the partner's interest in the partnership represents less than 10% of the capital and profits of the partnership at all times during the tax year; (ii) the partner is allocated less than 10% of each partnership item of income, gain, loss, deduction and credit for the tax year; and (iii) the partner's interest in the partnership has a fair market value of less than $25 million on the last day of the partner's tax year. Generally, if a partnership, or a branch of the partnership, is a registered securities dealer, each partner would be treated as a registered securities dealer. There is an exception for partners owning a small ownership interest in the registered securities dealer. For purposes of the de minimis exception for banking and registered securities dealer activities discussed earlier, a partner takes into account its distributive share of the relevant partnership items. Prop. Reg. Section 1.59A-9: Anti-abuse and recharacterization rules The Proposed Regulations would establish three anti-abuse rules for certain transactions that have "a principal purpose" of avoiding BEAT. Under the first proposed anti-abuse rule, the role of an intermediary would be disregarded (whether or not the intermediary is related to the taxpayer), or the amount paid or accrued to the intermediary would be treated as a base erosion payment, if three conditions are satisfied. First, the taxpayer pays or accrue an amount to one or more intermediaries that would have been a base erosion payment if paid or accrued to a foreign related party. Second, one or more of the intermediaries makes (directly or indirectly) corresponding payments to or for the benefit of a foreign related party. Third, the payments are made as part of a transaction (or series of transactions), plan or arrangement that has a principal purpose of avoiding a base erosion payment (or reducing the amount of a base erosion payment). Under the second proposed anti-abuse rule, a transaction (or component of a transaction or series of transactions), plan or arrangement that has a principal purpose of increasing the deductions taken into account for purposes of the denominator of the base erosion percentage computation would be disregarded for purposes of computing the percentage. Under the third proposed anti-abuse rule, a transaction (or series of transactions), plan or arrangement that occurs among related parties that has a principal purpose of avoiding the rules applicable to certain banks and registered securities dealers (i.e., the 2% threshold for the base erosion percentage test and increased base erosion and anti-abuse tax rate) would not be taken into account for purposes of those rules. Prop. Reg. Section 1.1502-59A: Application of BEAT to consolidated groups The Proposed Regulations provide that, for a consolidated group, determinations under Section 59A are generally made at the group level, as opposed to each separate entity. Relevant amounts of group members would be aggregated, and items from intercompany transactions under Reg. Section 1.1502-13 would not be taken into account. Classification of interest expense between domestic related, foreign related, and unrelated The classification of current interest expense as domestic related party, foreign related party, or unrelated party, would be made at the level of the consolidated group, whereas the deduction for disallowed interest carryforwards would be made on a separate-entity basis. The group's business deductions allowed under Section 163(j) (and other provisions of law) would be allocated first to related-party interest (pro rata between domestic and foreign), and then to unrelated-party interest. A member's current interest expense that is disallowed and carried forward would be allocated a status (i.e., domestic related, foreign related, or unrelated), and the deduction in a later year, when such interest expense is absorbed, would be based on the original status. If a member's disallowed interest carryforward is allocated a status and then the member leaves group, the carryforward would retain its allocated status, and the departing member (not the consolidated group) would take that status into account in future years. If a corporation joins a group, the status of any disallowed interest carryforward would be taken into account in determining the group's base erosion tax benefits when the carryforward is absorbed. Revisions to the reporting regulations under Section 6038A The Proposed Regulations would revise the existing reporting regulations under Section 6038A to take into account the additional information that must be reported concerning the BEAT on Forms 5472, 5471, 8858, as applicable, as well as Form 8991. These reporting requirements would generally apply for tax years beginning after December 31, 2017. The reporting requirements for QDPs, including the requirement to report the aggregate amount of QDPs for the tax year, and identity of each counterparty and the aggregate amount of QDP made to that counterparty, are proposed to apply to tax years beginning one year after final regulations are published in the Federal Register. Until those reporting rules are finalized for QDPs, a taxpayer will be treated as satisfying the reporting requirements necessary to exclude a QDP from being treated as a base erosion payment only to the extent it reports the aggregate amount of QDPs on Form 8991. Implications The Proposed Regulations address certain of the outstanding questions under Section 59A, and provide some much-needed guidance on the application of the gating thresholds and computational matters. In particular, the Proposed Regulations would clarify which entities are to be aggregated in order to evaluate the gross receipts test and base erosion percentage. Within this aggregate group framework, the regulations provide the ECI Exception, with the result that amounts subject to US tax as ECI would be excluded as base erosion payments. The guidance also confirms that the SCM exception applies to the cost component of a service for which a markup is charged (assuming certain requirements are satisfied), settling some interpretive disagreement in the taxpayer's favor. Further, based on the aggregate group approach, payments between group members would not be included for purposes of applying the gross receipts test. The Proposed Regulations would also clarify that the generally applicable lower 2% threshold does not apply to an aggregate or consolidated group that has de minimis bank or registered securities dealer activities. The Proposed Regulations will, however, likely mean some additional complexity for taxpayers in terms of gathering data and tracking certain items going forward. For example, removing inter-group transactions for purposes of the base erosion percentage and gross receipts test requires identifying such transactions, determining the amounts to be removed, and making the adjustments. Tracking the base erosion percentage in a loss year will be necessary to compute MTI going forward. Taxpayers will also need to track and evaluate transactions involving non-cash consideration and sales of property with built-in losses to determine the magnitude of base erosion payments, transactions that may not immediately be thought of as giving rise to a base erosion "payment." As noted, in underscoring that the Proposed Regulations do not establish any rules specific to Section 59A for purposes of determining whether a payment is deductible in the context of principal-agent, conduit and assignment of income situations, principles of general tax law apply. For example, leading cases include National Carbide v. Comm'r., 336 U.S. 422, 69 S. Ct. 726 (1949) and Comm'r. v. Bollinger, 485 U.S. 340 (1988) (evaluating the principles of agency relationship); also, Seven-Up Co. v. Comm'r., 14 T.C. 965 (1950) is particularly notable. Careful consideration should be given to ensure a complete facts and circumstances analysis is undertaken to assess the application of relevant principles and pertinent authorities, which are broader than the noted cases. Although the Proposed Regulations are comprehensive, they do not address a number of issues. For example, although the proposed regulations address how BEAT provisions interact with treaty-based determinations generally (e.g., in the context of income attributable to a PE), the Preamble does not mention Treasury's view on whether the BEAT provisions are congruent with the Nondiscrimination and Relief from Double Taxation provisions of current US tax treaties, a subject that has been much discussed by EU jurisdiction governments. Similarly, they do not address the treatment of payments made under an Advance Pricing Agreement; commenters had asked for those payments not to be treated as base erosion tax benefits, as they are amounts that have been negotiated by the relevant competent authorities as representing an arm's-length allocation of payments between related parties, consistent with US tax treaty obligations. The guidance also makes some interesting, and arguably inconsistent, policy choices. For example, although amounts subject to US tax as ECI would be excluded, payments made to a controlled foreign corporation that are includible in gross income by a US shareholder under Section 951(a) or Section 951A would continue to be treated as base erosion payments. For financial services taxpayers, the Proposed Regulations offer some favorable exceptions but may also have some unfavorable consequences. In particular, inbound banks benefit from the TLAC exception for required Federal Reserve funding, but home office regulatory funding requirements would not be eligible. In addition, inbound banks now have an exception for deductible payments made by US subsidiaries to their US branches and PEs; such amounts would not be base eroding payments, thus eliminating double taxation. On the other hand, outbound and inbound banks would now be required to net many third-party derivative contract payments and accruals (specifically with respect to notional principal contracts) that previously had been viewed on a gross-basis under the technical tax rules in effect pre-BEAT (and still in effect outside of BEAT). This treatment would have the disadvantage of increasing the base erosion percentage by virtue of lowering the amount of losses and deductions that could be included in the denominator. It would also have the disadvantage of requiring a re-work of data extractions necessary for performing BEAT computations. Careful review of the Proposed Regulations will be necessary to assess whether and/or to what extent taxpayers may be affected by BEAT, and may result in a redetermination of earlier modeling exercises. Comments are requests on several aspects of the Proposed Regulations and should provide an opportunity to address certain matters before finalization of the regulations, which is expected to occur in 2019, with the result that the final regulations would be effective for tax years beginning after December 31, 2017. ———————————————
——————————————— 1 This rate is increased to 12.5 % of modified taxable income for tax years beginning after December 31, 2025. 2 The exclusion of these credits from reducing an applicable taxpayer's regular tax liability amount in computing the BEAT no longer applies for tax years beginning after December 31, 2025. 3 A foreign person is considered a foreign related party for BEAT purposes if the foreign person is (i) a 25% owner of the taxpayer, (ii) related to the taxpayer or any 25% owner of the taxpayer (within the meaning of Sections 267(b) or 707(b)(1)), or (iii) related to the taxpayer under Section 482. The constructive ownership rules of Section 318 apply (subject to certain modifications) in determining whether the foreign person is a 25% owner of the taxpayer or a person related to a 25% owner. 4 Prop. Reg Section 1.59A-2(e)(3)(ii). | |||||||||||||||||||||||||||||||||||||||||||||||||||
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