Brian Abbey, Managing Director, International Tax Services
30-Second Summary:
- In today’s economic environment, the BEAT may apply to taxpayers who didn’t need to consider it as recently as three months ago.
- Considering recent economic developments and the CARES Act, it is worth revisiting BEAT, specifically the regulations issued in 2019. The final BEAT regulations are generally applicable to taxable years ending on or after December 17, 2018. However, taxpayers may apply the final regulations in their entirety for taxable years ending before December 17, 2018.
- This article examines the following regulatory highlights:
- The exclusion of corporate nonrecognition transactions and loss transactions from the scope of base erosion payments;
- Use of the “with-or-within method” to determine applicable taxpayer status across aggregate group members with different taxable years; and
- Most importantly, the election to waive allowable deductions provided in the proposed regulations.
Until recently, many U.S. taxpayers were not subject to the Base Erosion and Anti-Abuse Tax (BEAT). However, with the expected drop off in U.S. taxable income for 2020, the BEAT may capture taxpayers who three months ago did not have to give it much thought. In addition, the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides companies with the ability to increase their Section 163(j) limitation by increasing the 30% EBITDA limit to 50%. In the case of companies with significant intercompany debt, this increased interest deduction may further subject them to BEAT. It is worth noting that the upside to this increased interest deduction is that some companies may fall under the 3% threshold necessary to possibly be subject to BEAT.
Considering these developments, it is worth revisiting BEAT, specifically the regulations issued in 2019. Back on December 2, 2019, the IRS issued long-awaited final and proposed BEAT regulations,[1] following on proposed BEAT regulations published on December 21, 2018. The final and proposed regulations maintain the basic approach of the proposed regulations with a few, generally taxpayer-friendly, changes. In this post, we discuss some of the highlights:
- The exclusion of corporate nonrecognition transactions and loss transactions from the scope of base erosion payments;
- Use of the “with-or-within method” to determine applicable taxpayer status across aggregate group members with different taxable years; and
- Most importantly, the election to waive allowable deductions provided in the proposed regulations.
The final BEAT regulations are generally applicable to taxable years ending on or after December 17, 2018. However, taxpayers may apply the final regulations in their entirety for taxable years ending before December 17, 2018. Alternatively, taxpayers may apply the 2018 proposed regulations in their entirety for all taxable years ending on or before December 6, 2019 (date of publication of the final regulations in the federal register).
The 2019 proposed regulations are applicable to tax years ending on or after December 2, 2019, for partnership anti-abuse provisions (not discussed in this post) and taxable years beginning on or after December 6, 2019, for provisions relating to applicable taxpayer status and waiver of deductions. Taxpayers are permitted to rely on the 2019 proposed regulations in their entirety for tax years beginning after December 31, 2017, and before the final regulations are applicable. Taxpayers subject to BEAT in their 2018 and/or 2019 taxable years should consider how to best apply this complicated overlap of final and proposed regulations, considering ASC 740 implications as applicable.
Exceptions from Base Erosion Payments
The 2018 proposed regulations defined a base erosion payment to include “an amount paid or accrued using any form of consideration, including cash, property, stock, or the assumption of a liability.”[2] The preamble to the 2018 proposed regulations clarified that this definition was also intended to encompass corporate nonrecognition transactions under Sections 351, 332, and 368. For example, under the 2018 proposed regulations, a “tax-free” liquidation of a CFC into the U.S. under Section 332 could produce a base erosion payment to the extent depreciable/amortizable property was acquired by the U.S. parent in the transaction.
In the final regulations, the IRS excludes amounts transferred to or exchanged with foreign related parties under Sections 332, 351, 355, or 368 (“specified nonrecognition transactions”) from giving rise to base erosion payments.[3] However, to the extent that the specified nonrecognition transaction also involves the transfer of other property (i.e. “boot”)[4] to a foreign related party, the amount of other property transferred would potentially be a base erosion payment, regardless of whether gain is recognized on the transaction.[5]
Stock redemptions under Section 317(b) (including redemptions described in Section 302(a) and (d) or Section 306(a)(2)) as well as exchanges of stock in Section 304 redemptions and Section 331 liquidations are still considered amounts paid or accrued that may be base erosion payments.[6]
The exclusion of corporate nonrecognition transactions from base erosion payments is a welcome development for taxpayers, particularly those who were considering restructuring their foreign operations into foreign branches in response to the lower U.S. corporate tax rate and introduction of the GILTI regime. However, there are many other issues which must be taken into account in such a restructuring, including the foreign branch income redetermination rules in the final FTC regulations (the subject of a separate post).
In the same vein, the preamble to the 2018 proposed regulations stated that a loss recognized on the transfer of property with a built-in loss to a foreign related party would constitute a base erosion payment (i.e. treating the loss recognized as equivalent to a deduction and therefore subject to BEAT). The IRS reconsidered this rule in the final regulations, which now limit the amount of base erosion payment to the fair market value (“FMV”) of the property transferred.[7]
To illustrate, assume that a U.S. corporation (“US”), owned 100% by a foreign corporation (“FP”), transferred property with a FMV of 80 and adjusted basis of 100 (i.e. built-in loss of 20) to FP as payment for services provided by FP for which a deduction would otherwise be allowed to US. The transfer occurred in US’s 2018 taxable year.
Under the 2018 proposed regulations, U.S. would be treated as making 100 in base erosion payments to FP, including both 80 of FMV of the property transferred and 20 in loss recognized by US. The final regulations limit the amount of base erosion payment to 80, the FMV of the property transferred. The approach of the final regulations more closely reflects the economics of the transaction and does not inappropriately advantage payments made in cash vs. non-cash consideration for BEAT purposes
“With-or-Within” Method for Aggregate Groups
As background, a taxpayer is subject to BEAT (“applicable taxpayer”) only if the taxpayer meets both a $500 million average gross receipts test and a 3% base erosion percentage test in a taxable year.[8] These tests are applied at the level of the aggregate group, comprising all persons treated as a single employer under Section 52(a) (i.e., within a controlled group of corporations under Section 1563 but applying a 50% rather than 80% ownership threshold), disregarding the exception for foreign corporations under Section 1563(b)(2)(C).[9]
If an aggregate group contained multiple taxpayers with different taxable years, it was unclear how the gross receipts and base erosion tests should be calculated. The answer in the 2018 proposed regulations was to require each member of the aggregate group to calculate its gross receipts and base erosion percentage by reference to its own taxable year, considering the results of other members of its aggregate group during that taxable year. For example, if an aggregate group contained members with December 31, June 30, and September 30 U.S. tax year-ends, the member with a calendar year-end would have been required to recalculate the gross receipts, base erosion tax benefits, and deductions of the June 30 and September 30 year-end members on a calendar-year basis. The preamble to the 2018 proposed regulations allowed that this calculation could be performed using “a reasonable method,” an undefined term. This rule applied regardless of whether the taxable year of the member began before January 1, 2018, thereby requiring taxpayers to include items from other aggregate group members into their applicable taxpayer determination even if those other members were not yet subject to BEAT.[10]
In response to comments pointing out the administrative and conceptual difficulties[11] of the approach in the 2018 proposed regulations, the final regulations require that the gross receipts and base erosion percentage of a taxpayer’s aggregate group be determined based on the taxpayer’s taxable year and the taxable year of each member of the taxpayer’s aggregate group that ends with or within the applicable taxpayer’s taxable year (“with-or-within method”).[12] Taxable years of other aggregate group members beginning before January 1, 2018 (“excepted taxable years”) are not taken into account for purposes of the base erosion percentage test.[13] Further technical rules on applying the with-or-within method are included in the 2019 proposed regulations.
While the with-or-within method is generally helpful to taxpayers in simplifying their applicable taxpayer determinations, taxpayers do still need to have accurate, timely information on gross receipts, base erosion payments, and deductions of all other members in their aggregate group for both tax planning and ASC 740 purposes. This is likely to continue to prove challenging, especially where visibility into other aggregate group members may be limited, as is often the case when a private equity fund holds the taxpayer as part of a larger portfolio.
Election to Waive Allowable Deductions
The 3% cutoff of the base erosion percentage test in determining applicable taxpayer status results in a cliff effect, where a taxpayer may unexpectedly find itself subject to a large BEAT liability if it even slightly exceeds the 3% threshold. The code and final regulations specify that a deduction need only be “allowable” to create a base erosion payment and base erosion tax benefit.[14]
The 2019 proposed regulations provide for the possibility of waiving allowable deductions for all purposes of the Code and regulations,[15] which gives taxpayers some flexibility around managing their base erosion percentage. Taxpayers should be aware, however, that waiving a deduction under the 2019 proposed regulations would not eliminate the corresponding income inclusions if any (e.g., subpart F income or GILTI on payments from a U.S. company to its CFC).
The election to waive allowable deductions can be made on an original or amended return or during the course of an IRS examination, although once made, the election may not be subsequently revoked or the amount of waived elections decreased.[16] The election can be made on a year-by-year basis, so that waiving a deduction in one year does not require the deduction to be waived in subsequent years.
The 2019 proposed regulations anticipate that the election will be made on Form 8991. Taxpayers who wish to make use of the election before the 2019 proposed regulations are finalized may attach a statement to Form 8991 with the following information:
- A detailed description of the item or property to which the deduction relates, including sufficient information to identify that item or property on the taxpayer’s books and records;
- The date on which, or period in which, the waived deduction was paid or accrued;
- The provision of the Internal Revenue Code (and regulations, as applicable) that allows the deduction for the item or property to which the election relates;
- The amount of the deduction that is claimed for the taxable year with respect to the item or property;
- The amount of the deduction being waived for the taxable year with respect to the item or property;
- A description of where the deduction is reflected (or would have been reflected) on the Federal income tax return (schedule and line number); and
- The name, EIN (if applicable), and country of organization of the foreign related party that is or will be the recipient of the payment that generates the deduction.[17]
Waived deductions are not allocated/apportioned under Treas. Reg. §1.861-8 through -14T and 1.861-17.[18] The proposed regulations explicitly mention Section 904 as an example where this rule applies. To the extent that computation of gross Deduction Eligible Income and Foreign-Derived Deduction Eligible Income also follows Section 861 principles,[19] we would anticipate (pending final FDII regulations) that waived deductions would also not be allocated/apportioned in the FDII calculation. The waiver of the deduction is also disregarded for a few enumerated purposes listed in the proposed regulations, including determination of the basis in depreciable/amortizable assets, application of the exclusive apportionment rule for R&D, the transfer pricing regulations under Section 482, and for calculating E&P.[20]
Taxpayers who are subject to BEAT due to exceeding the 3% base erosion percentage threshold should carefully consider the election. In particular, taxpayers who were subject to BEAT in their 2018 taxable years may consider filing an amended return to take advantage of the ability to apply the 2019 proposed regulations prior to finalization. However, given the one-sided nature of the waiver taxpayers should analyze whether the waived deduction provides a tax benefit overall. Looking forward, a reexamination of transfer pricing policies and/or choice of entity for U.S. tax purposes could provide a more efficient way of managing BEAT exposure rather than reliance on waiving deductions.
We hope this post was helpful as navigate the impact of tax reform and COVID-19 on your business. Visit our tax reform page for the latest U. S. tax reform updates and our COVID-19 page that covers specific corporate tax impacts as a result of the COVID-19 pandemic.
About GTM’s International Tax Services
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[1] T.D. 9885.
[2] Prop. Reg. §1.59A-3(b)(2)(i).
[3] Treas. Reg. §1.59A-3(b)(3)(viii)(A).
[4] As defined in Sections 351(b), 356(a)(1)(B), and 361(b). Liabilities assumed in the specified nonrecognition transaction are also included in other property, but only to the extent of the amount of gain recognized under Section 357(c).
[5] Treas. Reg. §1.59A-3(b)(3)(viii)(B)
[6] Treas. Reg. §1.59A-3(b)(2)(ii).
[7] Treas. Reg. §1.59A-3(b)(2)(ix)
[8] Section 59A(e)(1)(B), (D).
[9] Section 59A(e)(3).
[10] Prop. Reg. §1.59A-2(e)(3)(vii).
[11] E.g., How deductions subject to annual limitation, such as the Section 163(j) interest limitation, could be calculated on a period other than the actual U.S. taxable year.
[12] Treas. Reg. §1.59A-2(c)(3).
[13] Treas. Reg. §1.59A-2(c)(8).
[14] Section 59A(d)(1); Treas. Reg. §1.59A-3(b)(1).
[15] Prop. Reg. §1.59A-3(c)(6)(i), (ii)(A)(1).
[16] Prop. Reg. §1.59A-3(c)(6)(iii).
[17] Prop. Reg. §1.59A-3(c)(6)(i).
[18] Prop. Reg. §1.59A-3(c)(6)(ii)(A)(2).
[19] Prop. Reg. §1.250(b)-1(d)(2)(i).
[20] Prop. Reg. §1.59A-3(c)(6)(ii)(B).
