Transfer Pricing for a BEAT World Transfer Pricing base erosion anti-abuse tax BEAT
In this continuation of GTM’s U.S. tax reform series, we discuss the new Base Erosion and Anti-Abuse Tax (BEAT, I.R.C. Section 59A) imposed by the Tax Cuts and Jobs Act (TCJA). This blog describes the key features of the BEAT and near-term practical steps taxpayers may take in addressing the BEAT, particularly with respect to transfer pricing. Transfer Pricing base erosion anti-abuse tax (BEAT)
What is BEAT?
The BEAT is a new minimum corporate income tax imposed on large corporations that make deductible payments to foreign related persons, called base erosion payments. Section 59A imposes a minimum tax calculated on a taxpayer’s taxable income, modified by excluding the tax benefits from base erosion payments (base erosion tax benefits) as well as a portion of any net operating loss (NOL) allowed for the tax year that arose from base erosion payments. The BEAT equals 5 percent of modified taxable income (MTI) for the taxable year beginning 2018, then increases to 10 percent for the tax years beginning 2019 through 2025, and finally caps at 12.5 percent for tax years beginning after December 31, 2025. All rates are 1 percentage point higher for banks and securities dealers.
Who is Affected?
The BEAT is not imposed on all taxpayers, but rather on large corporations that make deductible payments to foreign related persons exceeding a de minimis threshold. Applicable taxpayers are corporations (excluding regulated investment companies, real estate investment trusts, and S corporations) that are part of a group with an average of USD 500 million in gross receipts over the preceding three tax years, and that made base erosion payments during the tax year of 3 percent (base erosion percentage) or more of all deductible expenses, with certain exceptions. For purposes of calculating the revenue threshold, the group includes 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). For foreign corporations, only gross receipts from effectively connected income (ECI) are considered. Notably, the BEAT touches the U.S. subsidiaries of foreign multinationals. The base erosion percentage (3 percent threshold) is the total of base erosion tax benefits divided by the deductions allowable to the taxpayer for the year (excluding NOLs, participation exemptions, and the section 250 deduction for Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income (FDII)).
How is BEAT Calculated?
Calculation of MTI starts with regular taxable income, with base erosion tax benefits and the base erosion percentage of any allowed NOL added back. Base erosion payments are amounts paid or accrued to a foreign related party, including amounts includible in the basis of a depreciable or amortizable asset. Broadly speaking, payments included in cost of goods sold (COGS), for services accounted for under the services cost method (SCM), or for qualified derivatives are not base erosion payments. The portion of a payment subject to withholding under Sections 1441 or 1442 (for example, 1/3 of an interest payment withheld at a reduced 10% treaty rate) is also not a base erosion payment. Base erosion tax benefits are the deductions allowed with respect to base erosion payments, including the depreciation or amortization on property acquired with such payments.
The regular tax liability is determined after reduction by any credits, except for the research and development credit and a portion of the section 38 general business credits (GBC). GBC are allowed up to 80% of the lesser of the total section 38 credits amount or the base erosion minimum tax amount. For tax years beginning after December 31, 2025, the regular tax is reduced by all credits (including GBC). The BEAT stacks with the interest limitations under new section 163(j) so that any disallowed interest is treated as paid entirely to unrelated parties. The remaining related-party payments are then considered base erosion tax benefits and increase the BEAT liability.
Transfer Pricing Implications
Significant uncertainty remains around both aspects of Section 59A itself and interaction of the BEAT with other parts of the code including GILTI and FDII. Many taxpayers are understandably awaiting future guidance from the IRS before considering fundamental changes to operating or capital structures to adapt to the new U.S. international tax provisions. At the same time, calendar year-end companies should be completing their modeling and may be looking for short-term ways to reduce their 2018 BEAT liability. Remember that the BEAT does not apply below a base erosion percentage of 3 percent, so even small reductions in the numerator (base erosion tax benefits) or increases in the denominator (total deductions) may be significant to taxpayers who expect to be near this threshold.
As previously stated, services payments eligible for the SCM are not base erosion payments. There is some debate, however, around exactly which services (and what portion of payment for such services) qualifies for the BEAT exception. Some commentators argue that the service merely needs to be eligible for the SCM, but that the taxpayer is not required to apply the SCM when pricing the services transaction, and may thus charge a fee for the services that includes a profit element. Only the profit component, so the argument goes, would be considered a base erosion payment. Taxpayers taking this position would issue an invoice that segregates the service fee between the total services cost and the profit element. It would be important to clearly distinguish the services cost from the profit element. On April 25, Douglas Poms, Treasury international tax counsel, indicated in remarks at the annual NYU/KPMG Tax Lecture that Treasury had not yet taken a position on this issue. No matter the ultimate interpretation adopted in regulations, taxpayers should begin reviewing their intercompany transactions to identify services that might qualify under the expanded SCM definition, and consider possible changes in transfer pricing, operations or invoicing.
Another approach to mitigating BEAT exposure involves examining the taxpayer’s transfer pricing policies that provide an overall routine return. For example, a U.S. taxpayer may make a payment to a foreign related party that leaves it with an operating margin within a targeted benchmark range. It may be possible to unbundle the overall payment into several discrete payments that are more accurately accounted for as royalties, services, or cost of goods sold. As previously mentioned, COGS is not a base erosion payment, and the portion of services payments eligible for the SCM are also exempt from BEAT to some degree. Therefore, unbundling payments made to foreign related parties may help reduce BEAT exposure.
Until Treasury and IRS release guidance on the BEAT later this year, taxpayers should assess their potential BEAT exposure based on a reasonable interpretation of the law. We recommend that large companies meeting the USD 500 million gross receipts test inventory all payments to foreign related persons and notate which are potentially subject to the BEAT. Companies may then perform detailed calculations to evaluate whether they fall below the de minimis threshold, and are thus exempt from BEAT. If the company exceeds the gross receipts and de minimis thresholds, however, then each of the base erosion payments should be carefully examined. Opportunities may be available to refine current business and transfer pricing practices to reduce BEAT exposure, such as unbundling payments that may have an embedded COGS or services component, and bifurcating services payments eligible for the SCM between their cost and profit elements. Be careful to model BEAT exposure in conjunction with other provision of the TCJA, particularly the GILTI provisions and interest expense deduction limitations.
We hope this post was helpful as you assess the impact of tax reform on your business. GTM will be publishing regular posts highlighting key features and developments of U.S. tax reform. Visit our tax reform page for the latest U. S. tax reform updates.