Inspired in part by congressional concern that foreign-owned U.S. taxpayers had been reducing their U.S. income tax liabilities by making tax-deductible payments to a foreign parent or foreign related parties, Congress enacted Internal Revenue Code (IRC) Section 59A—tax on base erosion payments of taxpayers with substantial gross receipts—in connection with the Tax Cuts and Jobs Act. In an effort to reduce interpretive latitude on the part of taxpayers and resolve several unanswered questions, the IRS released a 193-page proposed regulation set on December 13, 2018. This new base erosion and anti-abuse tax, colloquially known as “BEAT,” involves complex modified tax computations; however, what may be even more difficult for many taxpayers is ascertaining whether they are subject to the BEAT.
In short, a BEAT-applicable taxpayer is required to recalculate taxable income without regard to certain tax deductions for base erosion payments made to foreign related parties. The result of this computation is modified taxable income to which the BEAT rate is then applied. To the extent the BEAT exceeds the taxpayer’s regular tax liability reduced by certain credits, the excess represents the BEAT liability. A base erosion payment does not include a reduction to a taxpayer’s gross receipts, i.e., a cost of goods sold item. Rather, a base erosion payment includes amounts paid or accrued by the taxpayer to a related foreign party for which a deduction is allowed. While exceptions do exist, deductible payments for interest, royalties and services, among other items, will ordinarily be considered base erosion payments.
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The BEAT applies to taxable years beginning after December 31, 2017. The BEAT rate is as follows:
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- 2018: 5 percent
- 2019–2025: 10 percent
- 2026 and thereafter: 12.5 percent
A U.S. taxpayer must determine whether it is a BEAT-applicable taxpayer, which could be an onerous task for multinational enterprises with complex organizational structures. Proposed Treasury Regulation §1.59A-2 sets forth the guidance needed to make this determination. A BEAT-applicable taxpayer must satisfy each of the following criteria:
- The taxpayer must be taxed as a C corporation; therefore, a BEAT-applicable taxpayer is not an S corporation, nor is it a regulated investment company or a real estate investment trust
- The taxpayer must have average annual gross receipts for the three-taxable-year period ending with the preceding taxable year in excess of $500 million
- The taxpayer must have a base erosion percentage of 3 percent or more
The BEAT shall only apply if all of the aforementioned tests are satisfied; however, U.S. taxpayers that are members of a group of corporations related by stock ownership must be aggregated for purposes of applying the gross receipts and base erosion percentage tests described above. This is an important distinction: A U.S. taxpayer looks to its controlled or “aggregate” group and considers all component members, both foreign and domestic, in determining whether the gross receipts and base erosion percentage tests are satisfied, thereby subjecting the U.S. taxpayer to the BEAT. Conversely, a BEAT-applicable taxpayer actually computes its modified taxable income, to which the BEAT rate is then applied on a standalone basis.
Section 59A and proposed regulations define the term “aggregate” group whereby all persons treated as a single employer under IRC §52(a) shall be treated as one person for purposes of the aforementioned tests. When defining a single employer, IRC §52(a) looks to IRC §1563 and the definition of a controlled group. IRC §1563 specifies that a controlled group includes either a parent-subsidiary controlled group or a brother-sister controlled group. A parent-subsidiary controlled group exists when a corporation owns 50 percent or more of the total combined voting power of all classes of stock entitled to vote or 50 percent or more of the total value of shares of all classes of stock of at least one other corporation. Note, the BEAT regulations use 50 percent as opposed to 80 percent, which is included in the statutory language of IRC §1563(a)(1) when determining whether or not a controlled group exists.
Moreover, a brother-sister controlled group exists if (i) five or fewer individuals, estates or trusts own more than 50 percent of the total combined voting power of all classes of stock entitled to vote or more than 50 percent of the total value of shares of all classes of stock of each corporation, considering only the stock ownership percentage of each shareholder that is identical with respect to each corporation, and (ii) at least 80 percent of the total combined voting power of all classes of stock entitled to vote or at least 80 percent of the total value of shares of all classes of stock of each corporation. As suggested above, foreign corporations are not considered to be excluded members for purposes of determining the composition of the BEAT aggregate group.
Consider the following example: A foreign corporation (FP) owns 100 percent of the stock of each of three subsidiaries—U.S. Corporation 1 (US1), U.S. Corporation 2 (US2) and Foreign Corporation (FC). FP and FC have a trade or business within the United States. Each of the four corporations would be component members of the aggregate group for BEAT purposes because they constitute a controlled group under IRC §1563(a)(1). Accordingly, the aggregate group as a whole must determine whether it satisfies the gross receipts and base erosion percentage tests. To the extent the tests are satisfied, US1 and US2 are BEAT-applicable taxpayers (assuming they are C corps and neither regulated investment companies nor real estate investment trusts).
Gross Receipts Test
A taxpayer, or the aggregate group of which it is a member, will satisfy the gross receipts test if it has average annual gross receipts of at least $500 million for the three-taxable-year period ending with the preceding taxable year. Quantifying gross receipts for the applicable tax year may prove burdensome in cases where component members of the aggregate group have different year-ends. Where a corporation with a calendar year-end is a member of an aggregate group, that corporation must calculate gross receipts of the entire aggregate group on a calendar-year basis without regard to the taxable year-end of any other member of the aggregate group. Similarly, where a corporation with a fiscal year-end is a member of an aggregate group, that corporation must calculate gross receipts of the entire aggregate group on a fiscal-year basis without regard to the taxable year-end of any other member of the aggregate group.
For example, using the same facts from above, assume US1 is attempting to determine whether or not it meets the gross receipts test. Assume also that US1 and US2 have a calendar year-end but FP and FC have June 30 year-ends. US1 must look to the gross receipts of each aggregate group member on a calendar-year basis. Thus, FP and FC must provide US1 with gross receipts data for the three-calendar-year periods ending with the preceding calendar year.
As noted above, an aggregate group may include both U.S. and foreign corporations for purposes of applying the gross receipts test. When measuring the gross receipts of a foreign corporation member of the aggregate group, only those gross receipts of the foreign corporation that are taken into account in determining income that is effectively connected with a U.S. trade or business are considered for the gross receipts test. In the case of a foreign corporation party to an aggregate group that calculates its net taxable income under an applicable U.S. income tax treaty, the foreign corporation includes only gross receipts that are attributable to transactions taken into account in determining its net U.S. taxable income for purposes of the gross receipts test. However, payments between the aggregate group and any related foreign corporation that is not within the aggregate group are still taken into account when applying the gross receipts test. Thus, it may be the case that a payment by a domestic corporation to a foreign corporation is not taken into account in determining applicable taxpayer status because the foreign payee is subject to net income tax in the U.S. on that payment, yet another payment made by the same domestic corporation to the same related foreign corporation is taken into account in determining applicable taxpayer status because the foreign payee is not subject to net income tax in the U.S. on that payment.
It is important to highlight that intra-aggregate group transactions are eliminated in measuring gross receipts of the aggregate group for purposes of applying the gross receipts test. For purposes of foreign corporation aggregate group members, only those intra-aggregate group transactions that relate to income effectively connected with a U.S. trade or business are disregarded and eliminated for purposes of the gross receipts test. Likewise, a foreign corporation aggregate group member that computes its U.S. net taxable income in accordance with an applicable U.S. income tax treaty shall disregard those transactions taken into account in determining its net U.S. taxable income.
There are several other points to consider in applying the gross receipts test. In cases where a taxpayer was not in existence for the three-taxable-year period ending with the preceding taxable year, the taxpayer would use the tax periods for which it was in existence and must annualize its gross receipts for the short taxable year, i.e., a tax period less than 12 months, by multiplying the gross receipts for the short period by 365 days and dividing the product by the number of days in the short period. Furthermore, those taxpayers party to a transaction described in IRC §381(a) relating to liquidations of subsidiaries or tax-free reorganizations must consider the gross receipts of the preceding distributor or transferor corporation where the taxpayer was the surviving or acquiring corporation.
Finally, it also should be noted that for purposes of the gross receipts test, gross receipts are reduced by returns and allowances made during a taxable year. In addition, gross receipts of consolidated groups are determined by aggregating the gross receipts of each member of the consolidated group.
Base Erosion Percentage Test
In general, a base erosion tax benefit is the value afforded to a taxpayer in the form of a tax deduction (and in some cases a reduction to gross income) resulting from a base erosion payment. A taxpayer or an aggregate group satisfies the base erosion percentage test if its base erosion percentage is 3 percent or higher. The base erosion percentage for a taxable year is calculated by dividing the taxpayer’s or the aggregate group’s base erosion tax benefits by the sum of (i) the aggregate amount of deductions allowed to the taxpayer or aggregate group, plus (ii) certain other base erosion tax benefits of the taxpayer or the aggregate group. Certain items are not considered in determining the base erosion percentage, such as a net operating loss (IRC §172), a foreign dividends received deduction (IRC §245A) and deductions related to global intangible low-taxed income and foreign-derived intangible income (IRC §250), among numerous other items. Moreover, in a manner consistent with the application of the gross receipts test, a taxpayer shall use either a calendar-year basis or a fiscal-year basis for determining the base erosion percentage where the taxpayer is a member of an aggregate group and other component members of the aggregate group have different year-ends.
A base erosion tax benefit also is excluded from the base erosion percentage test where U.S. tax was imposed on the related base erosion tax payment and the payer deducted and withheld U.S. withholding tax on that base erosion tax payment. The amount of base erosion tax benefit that is excluded from the test is equal to the gross benefit multiplied by a fraction equal to (i) the rate of tax imposed without regard to a U.S. tax treaty and reduced by the tax rate imposed by a U.S. tax treaty, over (ii) the tax rate imposed without regard to a U.S. tax treaty. This has the effect of excluding from the base erosion percentage those transactions that are already subject to U.S. tax.
Application to Partnerships
A partnership cannot be an applicable taxpayer for purposes of the BEAT. The proposed BEAT regulations apply an aggregate approach, and the BEAT is applied at the partner level. Generally speaking, any amount paid or accrued by a partnership is treated as though it were paid or accrued by the partner based on the partner’s distributive share amount as determined under IRC §704. A partner is not required, however, to consider its distributive share of any partnership base erosion tax benefits if all of the following criteria are satisfied:
Gross Receipts Test
A taxpayer, or the aggregate group of which it is a member, will satisfy the gross receipts test if it has average annual gross receipts of at least $500 million for the three-taxable-year period ending with the preceding taxable year. Quantifying gross receipts for the applicable tax year may prove burdensome in cases where component members of the aggregate group have different year-ends. Where a corporation with a calendar year-end is a member of an aggregate group, that corporation must calculate gross receipts of the entire aggregate group on a calendar-year basis without regard to the taxable year-end of any other member of the aggregate group. Similarly, where a corporation with a fiscal year-end is a member of an aggregate group, that corporation must calculate gross receipts of the entire aggregate group on a fiscal-year basis without regard to the taxable year-end of any other member of the aggregate group.
For example, using the same facts from above, assume US1 is attempting to determine whether or not it meets the gross receipts test. Assume also that US1 and US2 have a calendar year-end but FP and FC have June 30 year-ends. US1 must look to the gross receipts of each aggregate group member on a calendar-year basis. Thus, FP and FC must provide US1 with gross receipts data for the three-calendar-year periods ending with the preceding calendar year.
As noted above, an aggregate group may include both U.S. and foreign corporations for purposes of applying the gross receipts test. When measuring the gross receipts of a foreign corporation member of the aggregate group, only those gross receipts of the foreign corporation that are taken into account in determining income that is effectively connected with a U.S. trade or business are considered for the gross receipts test. In the case of a foreign corporation party to an aggregate group that calculates its net taxable income under an applicable U.S. income tax treaty, the foreign corporation includes only gross receipts that are attributable to transactions taken into account in determining its net U.S. taxable income for purposes of the gross receipts test. However, payments between the aggregate group and any related foreign corporation that is not within the aggregate group are still taken into account when applying the gross receipts test. Thus, it may be the case that a payment by a domestic corporation to a foreign corporation is not taken into account in determining applicable taxpayer status because the foreign payee is subject to net income tax in the U.S. on that payment, yet another payment made by the same domestic corporation to the same related foreign corporation is taken into account in determining applicable taxpayer status because the foreign payee is not subject to net income tax in the U.S. on that payment.
It is important to highlight that intra-aggregate group transactions are eliminated in measuring gross receipts of the aggregate group for purposes of applying the gross receipts test. For purposes of foreign corporation aggregate group members, only those intra-aggregate group transactions that relate to income effectively connected with a U.S. trade or business are disregarded and eliminated for purposes of the gross receipts test. Likewise, a foreign corporation aggregate group member that computes its U.S. net taxable income in accordance with an applicable U.S. income tax treaty shall disregard those transactions taken into account in determining its net U.S. taxable income.
There are several other points to consider in applying the gross receipts test. In cases where a taxpayer was not in existence for the three-taxable-year period ending with the preceding taxable year, the taxpayer would use the tax periods for which it was in existence and must annualize its gross receipts for the short taxable year, i.e., a tax period less than 12 months, by multiplying the gross receipts for the short period by 365 days and dividing the product by the number of days in the short period. Furthermore, those taxpayers party to a transaction described in IRC §381(a) relating to liquidations of subsidiaries or tax-free reorganizations must consider the gross receipts of the preceding distributor or transferor corporation where the taxpayer was the surviving or acquiring corporation.
Finally, it also should be noted that for purposes of the gross receipts test, gross receipts are reduced by returns and allowances made during a taxable year. In addition, gross receipts of consolidated groups are determined by aggregating the gross receipts of each member of the consolidated group.
Base Erosion Percentage Test
In general, a base erosion tax benefit is the value afforded to a taxpayer in the form of a tax deduction (and in some cases a reduction to gross income) resulting from a base erosion payment. A taxpayer or an aggregate group satisfies the base erosion percentage test if its base erosion percentage is 3 percent or higher. The base erosion percentage for a taxable year is calculated by dividing the taxpayer’s or the aggregate group’s base erosion tax benefits by the sum of (i) the aggregate amount of deductions allowed to the taxpayer or aggregate group, plus (ii) certain other base erosion tax benefits of the taxpayer or the aggregate group. Certain items are not considered in determining the base erosion percentage, such as a net operating loss (IRC §172), a foreign dividends received deduction (IRC §245A) and deductions related to global intangible low-taxed income and foreign-derived intangible income (IRC §250), among numerous other items. Moreover, in a manner consistent with the application of the gross receipts test, a taxpayer shall use either a calendar-year basis or a fiscal-year basis for determining the base erosion percentage where the taxpayer is a member of an aggregate group and other component members of the aggregate group have different year-ends.
A base erosion tax benefit also is excluded from the base erosion percentage test where U.S. tax was imposed on the related base erosion tax payment and the payer deducted and withheld U.S. withholding tax on that base erosion tax payment. The amount of base erosion tax benefit that is excluded from the test is equal to the gross benefit multiplied by a fraction equal to (i) the rate of tax imposed without regard to a U.S. tax treaty and reduced by the tax rate imposed by a U.S. tax treaty, over (ii) the tax rate imposed without regard to a U.S. tax treaty. This has the effect of excluding from the base erosion percentage those transactions that are already subject to U.S. tax.
Application to Partnerships
A partnership cannot be an applicable taxpayer for purposes of the BEAT. The proposed BEAT regulations apply an aggregate approach, and the BEAT is applied at the partner level. Generally speaking, any amount paid or accrued by a partnership is treated as though it were paid or accrued by the partner based on the partner’s distributive share amount as determined under IRC §704. A partner is not required, however, to consider its distributive share of any partnership base erosion tax benefits if all of the following criteria are satisfied:
- The partner’s interest is less than 10 percent of capital and profits for the entire taxable year
- The partner is allocated less than 10 percent of the partnership’s income, gain, loss, deduction and credit for the taxable year
- The partner’s interest has a fair market value of less than $25 million on the last day of the partner’s taxable year
Thus, when determining whether a corporate partner, which is an applicable taxpayer, has made a base erosion payment, amounts paid or accrued by a partnership are treated as being paid by the corporate partner to the extent an item of expense is allocated to the corporate partner under IRC §704. Further, any amounts received or accrued to a partnership are treated as received by the corporate partner to the extent the item of income or gain is allocated to the corporate partner under IRC §704. The rules and exceptions for base erosion payments and base erosion tax benefits then apply accordingly on an aggregate basis.
Furthermore, each corporate partner in a partnership must include its share of the partnership’s gross receipts for purposes of determining whether the corporate partner has satisfied the gross receipts test when ascertaining whether or not the corporate partner is a BEAT-applicable taxpayer. Note, however, that a foreign corporation shall only consider its share of gross receipts that are effectively connected with a U.S. trade or business or those gross receipts used to determine net U.S. taxable income in the case of a foreign corporation computing its net U.S. tax liability in accordance with a U.S. income tax treaty.
Finally, if a partner of a partnership is a partnership, then these rules must be successively applied until such time the ultimate partner is not itself a partnership.
Compliance
The regulations under §6038A were amended to include new reporting requirements on Form 8991, Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts. The regulatory language suggests that only a BEAT-applicable taxpayer is required to file Form 8991 with its annual income tax return; however, it would appear that any corporate taxpayer with gross receipts in excess of $500 million for any one of the three prior tax years will need to prepare and file Form 8991. Failure to comply may be costly, and a foreign-owned U.S. corporation that satisfies the Form 8991 reporting requirements but fails to file Form 8991 could draw a compliance penalty of $25,000.
It is obvious that BEAT is complex. While it may seem that BEAT will most likely apply only in an inbound context, it could similarly apply in an outbound context. Thus, it is important for any taxpayer with a foreign related party to review the BEAT provisions in greater detail as they relate to a specific set of facts and circumstances.
For more information, contact Justin or your trusted BKD advisor.
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