International tax planning is becoming a critical concern for organizations amid the COVID-19 pandemic and the resulting global economic environment. In order to help organizations navigate key international tax planning considerations during this unpredictable time, GTM is offering a series of updates that can serve as a useful planning checklist as you move further into the 2019 compliance season, while also considering your responses to the economic shocks of 2020.
The following post is a reminder of some common Base Erosion and Anti-Abuse Tax (“BEAT”) planning options, as well as some considerations that came out of the proposed BEAT regulations issued in December 2019. For a thorough examination of the final and proposed BEAT regulations, read our previous blog post here.
A taxpayer determines that it may be subject to BEAT due to being part of an aggregate group with three-year average gross receipts exceeding $500 million and having a base erosion percentage above 3% (i.e., deductions on payments to foreign related parties less than 3% of total deductions for a given taxable year). Many taxpayers focus their BEAT planning around the 3% cliff. If the 3% threshold is exceeded, base erosion payments should be reduced, or, if possible, eliminated, to minimize the BEAT liability.
BEAT and Costs of Good Sold (COGS)
One effective way to reduce the amount of base erosion tax payments is to consider whether outbound royalty payments should be embedded in costs of goods sold (COGS). For example, a U.S. subsidiary may act as a distributer for its foreign parent-manufacturer and pay both a royalty to the foreign parent to license the parent’s trademarks, patents, and other IP, and also make COGS payments for inventory to be resold in the U.S. The outbound royalty payment is a base erosion payment, while the COGS payment is generally excepted from the definition of a base erosion payment. To the extent that the uniform capitalization (UNICAP) rules of Sec. 263A permit the taxpayer to capitalize the royalty expense into inventory, the amount of base erosion payments will be reduced.
BEAT and Reducing Outbound Payments
Looking forward, taxpayers should also consider whether they may be able to eliminate certain outbound payments to related parties. For example, a multinational group may provide services to a customer on a worldwide basis but contract, bill, and collect payment from the customer in the U.S. When the U.S. group member pays a service fee to other group members which provided the service in each local country, the payments may be considered base erosion payments. Taxpayers should also examine arrangements providing for settlement on a net basis, as the final BEAT regulations confirm that the amount of a base erosion payment is determined on a gross basis, regardless of any contractual or legal right to make or receive payments on a net basis, except as otherwise provided for certain mark-to-market positions or as permitted by the Code or regulations.
BEAT and CBT Elections
Another option to reduce the amount of base erosion payments is to convert foreign subsidiaries from CFCs to foreign branches via check-the-box (“CTB”) elections, which will cause payments to these branches to be disregarded. Taxpayers considering CTB planning must consider the impact on their Sec. 904 FTC limitation across all affected baskets. Taxpayers should also keep in mind the 60-month limitation on subsequent CTB elections and Sec. 367 consequences on “unchecking” to convert back from a foreign branch to a CFC (due to, for example, a future increase in the U.S. corporate income tax rate or decrease in the foreign rate). For BEAT planning purposes, the election to waive deductions we illustrate in our example below achieves the same benefits as CTB planning but without the additional complications of converting to and operating in branch form.
If a taxpayer still finds itself exceeding the 3% base erosion percentage threshold, the taxpayer should then consider waiving deductions under the 2019 BEAT proposed regulations. For this post, we want to emphasize that, in certain circumstances, waiving deductions to avoid application of the BEAT may not be beneficial overall.
We consider two cases of a simple example involving a U.S. corporation which makes base erosion payments to its wholly-owned Indian CFC for R&D services:
In the first case, the U.S. corporation is in a taxable income position, and its regular U.S. tax liability is eliminated after taking into account FTCs. Electing to waive deductions on the outbound service payment eliminates the BEAT liability and produces a net decrease in total tax liability (regular tax plus BEAT).
In the second case, the taxpayer is in a loss position for regular tax purposes. Waiving deductions sufficient to fall below the 3% base erosion percentage threshold obviously eliminates the BEAT liability, but it also reduces the current year NOL generation. Because the CARES Act temporarily lifts the 80% taxable income and carryback limitations for pre-2021 NOLs, an increased current year NOL may have immediate cash tax benefits.
Although not shown in our simple example, taxpayers considering the election to waive deductions should also be aware of the 163(j) ordering rules, which considers Sec. 163(j) to first disallow deductions on unrelated party interest before disallowing deductions on foreign related business interest expense and domestic related business interest expense. This ordering rule preserves the maximum amount of deductible interest which is considered base erosion payments. Taxpayers should particularly note the interaction between this ordering rule and the CARES Act’s temporarily enhanced 163(j) limitations. If a taxpayer deducts more interest expense under the increased 163(j) limit, and that interest expense is considered paid to related foreign parties under the ordering rules, the taxpayer may have unexpectedly large amounts of base erosion payments and fail the 3% base erosion percentage test. Alternatively, the enhanced 163(j) limitation may allow more unrelated party interest to be deducted, decreasing the base erosion percentage.
The above represent simplified examples, and the exact interplay of BEAT, GILTI, and taxable income is very nuanced and interdependent. However, they serve to illustrate that waiving deductions may provide a BEAT benefit in some, but not all, cases. We advise our clients to proceed on the basis of thorough modeling which takes into account all of the interactions between the TCJA, CARES Act, and regulations under both which continue to be released.
Feel free to contact us directly at BAbbey@gtmtax.com and AWai@gtmtax.com with any questions. We will continue to provide international tax planning updates as we navigate this ever-changing business landscape.
 Sec. 59A(c)(3); Reg. §1.59A-3(c)(4)(ii)(B).
 For 2019 and 2020 taxable years, Sec. 163(j)(10) optionally increases the allowable interest deduction from 30% to 50% of ATI and permits taxpayers to use their 2019 ATI for their 2020 163(j) limitation.
 Reg. §1.59A-3(b)(1).
 e.g. Reg. §1.263A-1(e)(3)(ii)(U).
 A similar idea is to capitalize other BEAT payments where possible, like R&D payments through Sec. 59(e) elections.
 Taking into account generally applicable U.S. federal income tax law principles such as agency principles, reimbursement doctrine, case law conduit principles, assignment of income, etc.
 Reg. §1.59A-3(b)(2)(iii). The IRS declined to further clarify when netting is permitted “under the Code and regulations,” including whether netting is permitted for notional principal contracts and for cost sharing transaction payments under Reg. §1.482-7(j)(3)(i).
 Prop. Reg. §1.59A-3(c)(6). Please refer to our prior post on the BEAT final and proposed regulations for background on the election to waive deductions.