Treasury Issues Proposed Regulations on BEAT, a Provision Enacted as Part of the TCJA

The IRS and Treasury (collectively, Treasury) recently released proposed regulations (Proposed Regulations) on Section 59A, commonly referred to as the base erosion and anti-abuse tax (BEAT).  This provision was enacted as part of the 2017 tax reform known as the Tax Cuts and Jobs Act (TCJA).  In general, Section 59A imposes an additional tax on an “applicable taxpayer” equal to the base erosion minimum tax amount (BEMTA) for the taxable year.  For Section 59A to apply, there must be an applicable taxpayer.  In determining whether there is an applicable taxpayer, a gross receipts test (discussed below) and a specified “base erosion percentage” test (discussed below) must be satisfied.

The Proposed Regulations provide much needed guidance relating to the application of the BEAT.  More specifically, the Proposed Regulations include guidance relating to (i) whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed, (ii) base erosion payments, (iii) base erosion tax benefits arising from base erosion payments, (iv) the calculation of modified taxable income, (v) the BEMTA, (vi) the treatment of partnerships, (vii) banks and registered securities dealers in the context of the BEAT, (viii) insurance companies in the context of the BEAT, (ix) anti-abuse rules under the BEAT, (x) the general application of the BEAT to consolidated groups, (xi) amendments to Treas. Reg. §1.383-1 to address limitations on a loss corporation’s items under Section 382 and 383 in the context of the BEAT, and (xii) reporting and record keeping requirements relating to the BEAT.

This Alert highlights some of the important guidance contained in the Proposed Regulations.  For additional information on the Proposed Regulations, see REG-104259-18.
    

Applicable Taxpayer

Generally, an applicable taxpayer is a corporation (other than (1) a regulated investment company (RIC), (2) a real estate investment trust (REIT), or (3) an S corporation) that satisfies the gross receipts test and the base erosion percentage test. Section 59A and the Proposed Regulations provide that the taxpayer and certain other corporations that are related to the taxpayer are treated as one person for purposes of determining whether a taxpayer satisfies these tests.
 

Aggregation Rule of Section 59A(e)(3)

Section 59A(e)(3) aggregates corporations (aggregate group) on the basis of persons treated as a single employer under Section 52(a), which treats members of the “same controlled group of corporations” (as defined in Section 1563(a) with certain modifications) as one person. The Proposed Regulations provide guidance on the application of this rule including the following:

• The term aggregate group means the group of corporations determined by identifying a controlled group of corporations as defined in Section 1563(a), except that the phrase “more than 50 percent” is substituted for “at least 80 percent” each place it appears in Section 1563(a)(1) and the determination is made without regard to Sections 1563(a)(4) and (e)(3).
• A taxpayer must apply the gross receipts test and the base erosion percentage test using the aggregate group consisting of members of the same controlled group of corporations for purposes of Section 52(a) that are (i) domestic corporations and (ii) foreign corporations, but only with regard to gross receipts taken into account in determining income which is effectively connected with the conduct of a trade or business in the United States and subject to tax under Section 882(a).
• In the case of a foreign corporation that determines its net taxable income under an applicable income tax treaty of the United States, the foreign corporation is a member of the aggregate group with regard to gross receipts taken into account in determining its net taxable income.
• Payments between members of the aggregate group are not included in the gross receipts of the aggregate group, consistent with the single entity concept in Section 59A(e)(3). Similarly, payments between members of the aggregate group are also not taken into account for purposes of the numerator or the denominator in the base erosion percentage calculation.
• Payments between the aggregate group and any foreign corporation that is not within the aggregate group with respect to the payment are taken into account in applying both the gross receipts test and the base erosion percentage test. However, payments to a foreign corporation from within the aggregate group that are subject to net income tax in the United States are eliminated and not taken into account in applying the gross receipts test and the base erosion percentage 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 payee is subject to net income tax in the United States on that payment, while another payment by the same domestic corporation to the same foreign corporation is taken into account in determining applicable taxpayer status because the payee is not subject to net income tax in the United States on that payment.

 

Gross Receipts Test

A taxpayer satisfies the gross receipts test if the taxpayer, or the aggregate group of which the taxpayer is a member, has $500 million or more of average annual gross receipts during the three prior taxable years. The Proposed Regulations provide guidance on the application of this test including the following:

• In the case of a foreign corporation, the gross receipts test only takes into account gross receipts that are taken into account in determining income that is subject to net income tax as income effectively connected with the conduct of a trade or business within the United States, or taken into account in determining net taxable income under an applicable U.S. income tax treaty.
• -Gross receipts of a taxpayer are measured by reference to the taxpayer’s aggregate group determined as of the end of the taxpayer’s taxable year for which BEAT liability is being computed, and takes into account gross receipts of those aggregate group members during the three-year period preceding that taxable year.
• The Proposed Regulations further clarify how a taxpayer computes gross receipts, including providing rules for corporations that have been in existence for fewer than three years or have short years (the proposed rules are generally consistent with rules set forth in Section 448(c)) and also clarify how gross receipts are determined if members of the aggregate group have different taxable years.
• If a member of an aggregate group owns an interest in a partnership, the Proposed Regulations provide that the group includes its share of the gross receipts of the partnership in its gross receipts computation.

 

Base Erosion Percentage Test

The base erosion percentage test is satisfied with respect to a taxpayer if the taxpayer (or if the taxpayer is a member of an aggregate group, the aggregate group of which the taxpayer is a member) has a base erosion percentage of three percent or more. Generally, a lower threshold of two percent applies if the taxpayer, or a member of the taxpayer’s aggregate group, is a member of an affiliated group (as defined in Section 1504(a)(1)) that includes a domestic bank or registered securities dealer. The Proposed Regulations provide guidance on the base erosion percentage test including the following:

• The lower two percent threshold does not apply in the case of an aggregate group or consolidated group that has de minimis bank or registered securities dealer activities (as provided in the Proposed Regulations).
• The base erosion percentage for a taxable year is computed by dividing (1) the aggregate amount of base erosion tax benefits (the numerator) by (2) the sum of the aggregate amount of deductions plus certain other base erosion tax benefits (the denominator).
• In the case of a taxpayer that is a member of an aggregate group, the base erosion percentage is measured by reference to the deductions or certain reductions in gross income of the taxpayer and members of the taxpayer’s aggregate group as of the end of the taxpayer’s taxable year.
• Base erosion tax benefits are generally the deductions or reductions in gross income that result from base erosion payments.
• The numerator of the base erosion percentage excludes deductions for (i) amounts paid or accrued to foreign related parties for services qualifying for the exception in Prop. Reg. §1.59A-3(b)(3)(i) (the services cost method (SCM) exception), (ii) payments covered by the qualified derivatives payments (QDP) exception in Prop. Reg. §1.59A-3(b)(3)(ii), and (iii) amounts excluded pursuant to the total loss-absorbing capacity (TLAC) exception in Prop. Reg. §1.59A-3(b)(3)(v). Generally, these deductions are also excluded from the denominator of the base erosion percentage (subject to some exceptions as provided in the Proposed Regulations).
• Section 988 losses are excluded from the numerator and the denominator in determining the base erosion percentage.
• The numerator of the base erosion percentage only takes into account base erosion tax benefits, which generally are base erosion payments for which a deduction is allowed under the Code for a taxable year. Similarly, the denominator of the base erosion percentage only takes into account deductions allowed under the Code by providing that the denominator of the base erosion percentage does not include deductions that are not allowed in determining taxable income for the taxable year.
• If tax is imposed by Section 871 or 881 and that tax has been deducted and withheld under Section 1441 or 1442 on a base erosion payment, the base erosion payment is not treated as a base erosion tax benefit for purposes of calculating a taxpayer’s modified taxable income. If an income tax treaty reduces the amount of withholding imposed on the base erosion payment, the base erosion payment is treated as a base erosion tax benefit to the extent of the reduction in withholding under rules similar to those in Section 163(j)(5)(B) as in effect before the TCJA.
• A base erosion tax benefit is not included in the numerator when the payment was subject to tax under Section 871 or 881 and that tax has been deducted and withheld under Section 1441 or 1442. In addition, for any base erosion payment subject to a reduced rate of withholding tax under an income tax treaty, the associated amount of base erosion tax benefits eliminated from the numerator of the base erosion percentage calculation is determined using rules similar to those in Section 163(j)(5)(B) as in effect before the TCJA. Similarly, the base erosion percentage also takes into account the two categories of base erosion tax benefits that result from reductions in gross income rather than deductions allowed under the Code (that is, (1) certain premium or other consideration paid to a foreign related party for reinsurance, and (2) amounts paid or accrued by the taxpayer to certain surrogate foreign corporations that result in a reduction in gross receipts to the taxpayer). Section 59A(c)(4)(A)(ii)(II) provides that those base erosion tax benefits that result from reductions in gross income are included in the both the numerator and the denominator in the same amount. Other payments that reduce gross income but that are not base erosion payments are not included in the denominator of the base erosion percentage.

 

Taxpayers in an Aggregate Group with Different Taxable Years

• The Proposed Regulations provide rules for determining whether the gross receipts test and base erosion percentage test are satisfied with respect to a specific taxpayer when other members of its aggregate group have different taxable years.
• In general, the Proposed Regulations provide that each taxpayer determines its gross receipts and base erosion percentage by reference to its own taxable year, taking into account the results of other members of its aggregate group during that taxable year.
• For purposes of determining the gross receipts, base erosion tax benefits, and deductions of the aggregate group, the taxpayer must include those amounts that occur during the course of the taxpayer’s own taxable year, not another member of the aggregate group’s taxable year, if different.
• As a result of this rule, two related taxpayers with different taxable years will compute their applicable gross receipts and base erosion percentage by reference to different periods, even though in each case the calculations are done on an aggregate group basis that takes into account other members of the controlled group. Taxpayers may use a reasonable method to determine the gross receipts and base erosion percentage information for the time period of the member of the aggregate group with a different taxable year.
• When determining the base erosion percentage for a taxpayer that is a member of an aggregate group with other members that have a different taxable year, the effective date in Section 14401(e) of the TCJA, as it applies to the taxpayer making the return, controls whether that taxpayer takes into account transactions of other members of its aggregate group. (Section 14401(e) of the TCJA provides that Section 59A applies only to base erosion payments paid or accrued in taxable years beginning after December 31, 2017.)
• Thus, if one corporation (US1) that has a calendar year is a member of an aggregate group with another corporation (US2) that has a taxable year ending November 30, when US1 computes its base erosion percentage for its calendar year ending December 31, 2018, the base erosion payments made by US2 during the period from January 1, 2018, through December 31, 2018, are taken into account with respect to US1 for its computations even though US2’s base erosion payments in its taxable year ending November 30, 2018, are not base erosion payments with respect to US2 because of Section 14401(e) of the TCJA. Correspondingly, US2’s taxable year beginning December 1, 2017, and ending November 30, 2018, is not subject to Section 59A because US2’s base erosion payments occur in a year beginning before January 1, 2018, and base erosion payments made by US1 during the period from December 1, 2017, through November 30, 2018, do not change that result.

 

Mark-to-Market Deductions

The Proposed Regulations provide rules for determining the amount of base erosion tax benefits in the case of transactions that are marked to market.
 

Base Erosion Payments

The Proposed Regulations define a base erosion payment as a payment or accrual by the taxpayer to a foreign related party (as defined in Prop. Reg. §1.59A-1(b)(12)) that is described in one of four categories: (1) a payment with respect to which a deduction is allowable; (2) a payment made in connection with the acquisition of depreciable or amortizable property; (3) premiums or other consideration paid or accrued for reinsurance that is taken into account under Section 803(a)(1)(B) or 832(b)(4)(A); or (4) a payment resulting in a reduction of the gross receipts of the taxpayer that is with respect to certain surrogate foreign corporations or related foreign persons. The Proposed Regulations provide details relating to base erosion payments including the following:

• A payment or accrual that is not within one of the categories may be a base erosion payment described in one of the other categories.
• Except as otherwise provided in the Proposed Regulations, the determination of whether a payment or accrual by the taxpayer to a foreign related party is described in one of these four categories is made under general U.S. federal income tax law.  For example, the Proposed Regulations do not explicitly address whether a royalty payment is classified as deductible under Section 162 or as a cost includible in inventory under Sections 471 and 263A resulting in a reduction in gross income under Section 61.
• A payment or accrual by a taxpayer to a foreign related party may be a base erosion payment regardless of whether the payment is in cash or in any form of non-cash consideration (thus, a nonrecognition transaction can result in base erosion payment). The preamble to the Proposed Regulations cites as illustrations a domestic corporation’s acquisition of depreciable assets from a foreign related party in an exchange described in Section 351, a liquidation described in Section 332, and a reorganization described in Section 368.
• However, for transactions in which a taxpayer that owns stock in a foreign related party receives depreciable property from the foreign related party as an in-kind distribution subject to Section 301, there is no base erosion payment because there is no consideration provided by the taxpayer to the foreign related party in exchange for the property. Thus, there is no payment or accrual.
• A base erosion payment also can include a payment to a foreign related party resulting in a recognized loss.
• The Proposed Regulations generally provide that a foreign corporation that has interest expense allocable under Section 882(c) to income that is effectively connected with the conduct of a trade or business within the United States will have a base erosion payment to the extent the interest expense results from a payment or accrual to a foreign related party. The amount of interest that will be treated as a base erosion payment depends on the method used under Treas. Reg.  §1.882-5.
• The amount of a foreign corporation’s other deductions properly allocated and apportioned to effectively connected gross income under Treas. Reg. §1.882-4 are base erosion payments to the extent that those deductions are paid or accrued to a foreign related party.
• If a foreign corporation engaged in a trade or business within the United States acquires property of a character subject to the allowance for depreciation (or amortization in lieu of depreciation) from a foreign related party, the amount paid or accrued by the taxpayer to the foreign related party is a base erosion payment to the extent the property is used, or held for use, in the conduct of a trade or business within the United States.
• The Proposed Regulations contain special rules when income tax treaties are asserted by foreign corporations. The Proposed Regulations require that certain  deductions from internal dealings allowed in computing the business profits of the permanent establishment be treated in a manner consistent with their treatment under the treaty-based position and be included as base erosion payments.
• The Proposed Regulations also provide rules for certain payments to a domestic trust, REIT or RIC, and for certain payments to a related domestic corporation that is not part of a consolidated group.

 

Exceptions to Base Erosion Payments

The Proposed Regulations provide details on various exceptions to base erosion payments, including the following:
 

The Services Cost Method Exception

• The SCM exception described in Section 59A(d)(5) provides that Section 59A(d)(1) (which sets forth the general definition of a base erosion payment) does not apply to any amount paid or accrued by a taxpayer for services if (A) the services are eligible for the SCM under Section 482 (determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure) and (B) the amount constitutes the total services cost with no markup component.
• The Proposed Regulations provide that the SCM exception 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 is not eligible for the SCM exception and is a base erosion payment.
• To be eligible for the SCM exception, all of the requirements of Treas. Reg. §1.482-9(b) must be satisfied, except as modified by the Proposed Regulations. Therefore, a taxpayer’s determination that a service qualifies for the SCM exception is subject to review under the requirements of Treas. Reg. §1.482-9(b)(3) and (b)(4), and its determination of the amount of total services cost and allocation and apportionment of costs to a particular service is subject to review under the rules of Treas. Regs. §1.482-9(j) and §1.482-9(k), respectively.
• Although the Proposed Regulations do not require a taxpayer to maintain separate accounts to bifurcate the cost and markup components of its services charges to qualify for the SCM exception, the Proposed Regulations do require that taxpayers maintain books and records adequate to permit verification of, among other things, the amount paid for services, the total services cost incurred by the renderer, and the allocation and apportionment of costs to services in accordance with Treas. Reg. §1.482-9(k). Because payments for certain services that are not eligible for the SCM due to the business judgment rule or for which taxpayers select another transfer pricing method may still be eligible for the SCM exception to the extent of total services cost, the record-keeping requirements in the Proposed Regulations differ from the requirements in Treas. Reg. §1.482-9(b)(6).
• Unlike Treas. Reg. §1.482-9(b)(6), the Proposed Regulations do not require that taxpayers “include a statement evidencing [their] intention to apply the services cost method to evaluate the arm's length charge for such services,” but the Proposed Regulations do require that taxpayers include a calculation of the amount of profit mark-up (if any) paid for the services.
• For purposes of qualifying for the SCM exception under Section 59A(d)(5), taxpayers are required to comply with the books and records requirements under these Proposed Regulations but not Treas. Reg. §1.482-9(b)(6).
• The Proposed Regulations also clarify that the parenthetical reference in Section 59A(d)(5) to the business judgment rule prerequisite for applicability of the SCM -- “(determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure)” -- disregards the entire requirement set forth in Treas. Reg. §1.482-9(b)(5) solely for purposes of Section 59A(d)(5).

 

Observation from BDO's Transfer Pricing Group

• In terms of intercompany services payments, only the mark-up portion of the payment is included in the add-back for the calculation of the modified taxable income and therefore is subject to BEAT. It is important to identify those services that satisfy the requirements of Treas. Reg. §1.482-9(b) to help minimize the BEAT.  A taxpayer's determination that a service qualifies for the SCM exception is subject to review under the requirements of Treas. Reg. §1.482-9(b)(3) and (b)(4), and its determination of the amount of total services cost and allocation and apportionment of costs to a particular service is subject to review under the rules of Treas. Reg. §1.482-9(j) and Section 1.482-9(k).
• One of the most important exceptions is that no amount is added back for BEAT calculations which reduces the taxpayer's gross receipts such as COGS and any other payment that can be included in COGS, such as certain procurement commissions. Hence understanding and characterizing transaction flows from an economic perspective by breaking apart the elements of the payments such as royalties may help taxpayers minimize their BEAT exposure. For example, royalty payments related to products that are imported may be included in the product cost, or re-evaluation of certain services payments to assess whether those services are integral to the product and service offerings of the taxpayer may achieve inclusion of costs in COGS.
• Typically, the aforementioned detailed unbundling and payment character determinations are performed by transfer pricing groups through economic analysis and as such, consultations would be beneficial.

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Exception to Base Erosion Payment Status for Payments the Recipient of which is Subject to U.S. Tax

• Treasury concluded that a payment to a foreign person should not be taxed as a base erosion payment to the extent that payments to the foreign related party are effectively connected income. Those amounts are subject to tax under Sections 871(b) and 882(a) on a net basis in substantially the same manner as amounts paid to a United States citizen or resident or a domestic corporation.
• There is an exception from the definition of base erosion payment for amounts that are subject to tax as income effectively connected with the conduct of a U.S. trade or business.
• In the case of a foreign recipient that determines its net taxable income under an applicable income tax treaty, the exception from the definition of base erosion payment applies to payments taken into account in determining net taxable income under the treaty.

The Proposed Regulations also include guidance on exceptions to base erosion payments relating to (i) qualified derivative payments, (ii) exchange loss from a Section 988 transaction, and (iii) interest on certain instruments issued by Globally Systemically Important Banking Organizations.
 

Base Erosion Payments Occurring Before the Effective Date and Pre-2018 Disallowed Business Interest

The Proposed Regulations provide guidance as it relates to the above topic including the following guidance:

• Section 14401(e) of the TCJA provides that Section 59A applies only to base erosion payments paid or accrued in taxable years beginning after December 31, 2017. The Proposed Regulations confirm the exclusion of a deduction described in Section 59A(c)(2)(A)(i) (deduction allowed under Chapter 1 for the taxable year with respect to any base erosion payment) or Section 59A(c)(2)(A)(ii) (deduction allowed under Chapter 1 for the taxable year for depreciation or amortization with respect to any property acquired with such payment) that is allowed in a taxable year beginning after December 31, 2017, if it relates to a base erosion payment that occurred in a taxable year beginning before January 1, 2018.
• In the case of business interest expense that is not allowed as a deduction under Section 163(j)(1), the Proposed Regulations provide a rule that clarifies that the effective date rules apply in a similar manner as with other base erosion payments that initially arose before the effective date in Section 14401(e) of the TCJA.
• The Proposed Regulations provide that any disallowed disqualified interest under Section 163(j) that resulted from a payment or accrual to a foreign related party and that is carried forward from a taxable year beginning before January 1, 2018, is not a base erosion payment. The Proposed Regulations also clarify that any disallowed business interest carryforward under Section 163(j) that resulted from a payment or accrual to a foreign related party is treated as a base erosion payment in the year that the interest was paid or accrued even though the interest may be deemed to be paid or accrued again in the year in which it is actually deducted.
• The Proposed Regulations do not follow the approach described in Notice 2018-28 as it relates to a BEAT payment.

 

Base Erosion Tax Benefits

The amount of base erosion tax benefits is an input in (i) the computation of the base erosion percentage test and (ii) the determination of modified taxable income. Generally, a base erosion tax benefit is the amount of any deduction relating to a base erosion payment that is allowed under the Code for the taxable year. The Proposed Regulations provide guidance on base erosion tax benefits including the following:

• If tax is imposed by Section 871 or 881 and the tax is deducted and withheld under Section 1441 or 1442 without reduction by an applicable income tax treaty on a base erosion payment, the base erosion payment is treated as having a base erosion tax benefit of zero for purposes of calculating a taxpayer’s modified taxable income.
• If an income tax treaty reduces the amount of withholding imposed on the base erosion payment, the base erosion payment is treated as a base erosion tax benefit to the extent of the reduction in withholding under rules similar to those in Section 163(j)(5)(B) as in effect before the TCJA.
• Prop. Reg. §1.59A-3(c)(4) provides rules coordinating Section 163(j) with the determination of the amount of base erosion tax benefits. This rule provides, consistent with Section 59A(c)(3), that where Section 163(j) applies to limit the amount of a taxpayer’s business interest expense that is deductible in the taxable year, a taxpayer is required to treat all disallowed business interest first as interest paid or accrued to persons who are not related parties, and then as interest paid or accrued to related parties for purposes of Section 59A. More specifically, when a corporation has business interest expense paid or accrued to both unrelated parties and related parties, the amount of allowed business interest expense is treated first as the business interest expense paid to related parties, proportionately between foreign and domestic related parties, and then as business interest expense paid to unrelated parties. Conversely, the amount of a disallowed business interest expense carryforward is 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.
• Because Section 163(j) and the proposed regulations thereunder provide an ordering rule that allocates 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) in order to separately track the attributes on a year-by-year layered approach for subchapter C purposes, the Proposed Regulations follow that convention. Accordingly, the Proposed Regulations also follow a year-by-year convention in the allocation of business interest expense and carryovers among the related and unrelated party classifications. The Proposed Regulations adopt a similar approach for business interest expense and excess business interest of a partnership that is allocated to a corporate partner by separately tracking and ordering items allocated from a partnership.

 

Modified Taxable Income

Modified taxable income is a necessary element in calculating the tax under Section 59A. The Proposed Regulations provide guidance on modified taxable income including the following:

• Section 59A(c)(1) provides that the term modified taxable income means the taxable income of the taxpayer computed under Chapter 1 for the taxable year, determined without regard to base erosion tax benefits and the base erosion percentage of any NOL deduction under Section 172 for the taxable year.
• The computation of modified taxable income and the computation of the BEMTA are made on a taxpayer-by-taxpayer basis.
• The computation of modified taxable income is done on an add-back basis. The computation starts with taxable income (or taxable loss) of the taxpayer as computed for regular tax purposes, and adds to that amount (a) the gross amount of base erosion tax benefits for the taxable year and (b) the base erosion percentage of any NOL deduction under Section 172 for the taxable year.
• If a taxpayer has an excess of deductions allowed by Chapter 1 over gross income, computed without regard to the NOL deduction, the taxpayer has negative taxable income for the taxable year. Generally, the Proposed Regulations provide that a negative amount is the starting point for computing modified taxable income when there is no NOL deduction from net operating loss carryovers and carrybacks.
• The Proposed Regulations further provide a rule applicable to situations in which there is a NOL deduction from a net operating loss carryover or carryback to the taxable year and that NOL deduction exceeds the amount of positive taxable income before that deduction (because, for example, the loss arose in a year beginning before January 1, 2018). The Proposed Regulations provide that the excess amount of NOL deduction does not reduce taxable income below zero for determining the starting point for computing modified taxable income.
• The NOL deduction taken into account for purposes of adding the base erosion percentage of the NOL deduction to taxable income under Section 59A(c)(1)(B) is determined in the same manner as above.
• An applicable taxpayer’s taxable income is determined according to Section 63(a) without regard to the rule in Section 860E(a)(1).
• Prop. Reg. §1.59A-4(b)(2)(ii) applies the base erosion percentage of the year in which the loss arose, or vintage year, because the base erosion percentage of the vintage year reflects the portion of base eroding payments that are reflected in the net operating loss carryover.
• In the case of net operating losses that arose in taxable years beginning before January 1, 2018, and that are deducted as carryovers in taxable years beginning after December 31, 2017, the base erosion percentage is zero because Section 59A applies only to base erosion payments that are paid or accrued in taxable years beginning after December 31, 2017.  As a result, there is no add-back to modified taxable income for the use of those net operating loss carryovers.
• In computing the add-back for NOL deductions for purposes of the modified taxable income calculation, the relevant base erosion percentage is the base erosion percentage for the aggregate group that is used to determine whether the taxpayer is an applicable taxpayer, rather than a separate computation of base erosion percentage computed solely by reference to the single taxpayer.

 

Base Erosion Minimum Tax Amount

Generally, the taxpayer’s BEMTA equals the excess of (1) the applicable tax rate for the taxable year (BEAT rate) multiplied by the taxpayer’s modified taxable income for the taxable year over (2) the taxpayer’s adjusted regular tax liability for that year.

• In determining the taxpayer’s adjusted regular tax liability for the taxable year, credits (including the foreign tax credit) are generally subtracted from the regular tax liability amount.
• Credits for overpayment of taxes and for taxes withheld at source are not subtracted from the taxpayer’s regular tax liability because these credits relate to federal income tax paid for the current or previous year.
• For taxable years beginning before January 1, 2026, under Section 59A(b)(1)(B), the credits allowed against regular tax liability (which reduce the amount of regular tax liability for purposes of calculating BEMTA) are not reduced by the research credit determined under Section 41(a) or by a portion of applicable Section 38 credits.
• For taxable years beginning after December 31, 2025, this special treatment of the research credit and applicable Section 38 credits no longer applies. As a result, an applicable taxpayer may have a greater BEMTA than would be the case in taxable years beginning before January 1, 2026.
• In general, foreign tax credits are taken into account in computing a taxpayer’s regular tax liability before other credits. See Section 26(a). As a result, a taxpayer with foreign tax credits that reduce its regular tax liability to, or close to, zero may not use its Section 41(a) credits or its applicable Section 38 credits in computing its regular tax liability. In these situations, those credits will not be taken into account in computing the taxpayer’s BEMTA even in a pre-2026 year. Instead, those credits will reduce (or, put differently, will prevent an increase in) the BEMTA in the year when those credits are used for regular tax purposes (provided that the taxable year begins before January 1, 2026).

 

Application of Section 59A to Partnerships

• The Proposed Regulations generally apply an aggregate approach in conjunction with the gross receipts test for evaluating whether a corporation is an applicable taxpayer and in addressing the treatment of payments made by a partnership or received by a partnership for purposes of Section 59A.
• The Proposed Regulations generally provide that partnerships are treated as an aggregate of the partners in determining whether payments to or payments from a partnership are base erosion payments consistent with the approach described in subchapter K as well as the authority provided in Section 59A(i)(1) to prescribe such regulations that are necessary or appropriate to carry out the provisions of Section 59A, including through the use of intermediaries or by characterizing payments otherwise subject to Section 59A as payments not subject to 59A.
• Partners with certain small ownership interests are excluded from this aggregate approach for purposes of determining base erosion tax benefits from the partnership. This small ownership interests exclusion generally applies to partnership interests that represent less than ten percent of the capital and profits of the partnership and less than ten percent of each item of income, gain, loss, deduction, and credit, and that have a fair market value of less than $25 million.
• The Proposed Regulations do not provide for special treatment of base erosion tax benefits attributable to a partnership or to partnership nonrecognition transactions. Instead, the aggregate principle generally applies to these situations. For example, if a partnership acquires property from a foreign related party of a taxpayer that is a partner in the partnership, deductions for depreciation of the property allocated to the taxpayer generally are base erosion tax benefits.
• With respect to any person that owns an interest in a partnership, the related party determination under Section 59A(g) applies at the partner level.

 

Guidance Relating to Certain Taxpayers

The Proposed Regulations also include guidance and special rules for certain types of taxpayers, including banks, dealers and insurance companies.
 

Anti-Abuse and Recharacterization Rules

• Prop. Reg. §1.59A-9(b) provides that certain transactions that have a principal purpose of avoiding Section 59A will be disregarded or deemed to result in a base erosion payment.
• This proposed anti-abuse rule addresses the following types of transactions: (a) transactions involving intermediaries acting as a conduit to avoid a base erosion payment; (b) transactions entered into to increase the deductions taken into account in the denominator of the base erosion percentage; and (c) transactions among related parties entered into to avoid the application of rules applicable to banks and registered securities dealers (for example, causing a bank or registered securities dealer to disaffiliate from an affiliated group so as to avoid the requirement that it be a member of such a group).

 

Consolidated Groups as Taxpayers

• For affiliated corporations electing to file a consolidated income tax return, the tax under Section 59A is determined at the consolidated group level, rather than determined separately for each member of the group.
• This single taxpayer treatment for members of a consolidated group applies separately from the aggregate group concept in Prop. Reg.  §1.59A-2(c), which also treats all members of the aggregate group as a single entity, but in that case, only for purposes of applying the gross receipts test and base erosion percentage test for determining whether a particular taxpayer is an applicable taxpayer.
• Items from intercompany transactions are not taken into account for purposes of making the computations under Section 59A.

 

Coordinating Consolidated Group Rules for Sections 59A(c)(3) and 163(j)

• Where Section 163(j) applies to limit the amount of a taxpayer’s business interest that is deductible in a taxable year, the taxpayer is required to treat all disallowed business interest as allocable first to interest paid or accrued to persons who are not related parties, and then to related parties.
• There are rules relating to applying these rules when there is a consolidated group. Prop. Reg. §1.1502-59A provides rules regarding application of Section 59A(c)(3) to consolidated groups.

 

Consolidated Tax Liability and Sections 382 and 383

There is guidance relating to the above items as it relates to the BEAT.  
 

Reporting and Recordkeeping Requirements Pursuant to Section 6038A

• The TCJA amended Section 6038A by adding paragraph (b)(2), which authorizes regulations requiring information from a reporting corporation (see Sections 6038A and 6038C for reporting corporation) that is also a Section 59A “applicable taxpayer” for purposes of administering Section 59A. Section 6038A(b)(2) applies to taxable years beginning after December 31, 2017.
• The Proposed Regulations identify certain types of information that will be required to be reported on Form 5472 and Form 8991, Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts, and also provide the time and manner for reporting.
• While an applicable taxpayer that is not a reporting corporation would not be subject to monetary penalties and collateral provisions specific to Sections 6038A and 6038C, the taxpayer remains subject to BEAT-related reporting obligations, including Form 8991, and applicable consequences for noncompliance.
• The Proposed Regulations require all reporting corporations to state whether a foreign shareholder required to be listed on Form 5472 is a surrogate foreign corporation.
• The Proposed Regulations clarify that the IRS may require by form or by form instructions the following information: (1) reporting of particular details of the reporting corporation’s relationships with related parties in regard to which it is required to file a Form 5472, (2) reporting of transactions within certain categories on a more detailed basis, (3) reporting of the manner (such as type of transfer pricing method used) in which the reporting corporation determined the amount of particular reportable transactions and items, and (4) summarization of a reporting corporation’s reportable transactions and items with all foreign related parties on a schedule to its annual Form 5472 filing.

 

Proposed Applicability Date

Under Section 7805(b)(2), and consistent with the applicability date of Section 59A, these regulations (other than the proposed reporting requirements for QDPs in Prop. Reg. §1.6038A-2(b)(7)) are proposed to apply to taxable years beginning after December 31, 2017. Until finalization, a taxpayer may rely on these Proposed Regulations for taxable years beginning after December 31, 2017, provided the taxpayer and all related parties of the taxpayer (as defined in Prop. Reg. §1.59A-1(b)(17)) consistently apply the Proposed Regulations for all those taxable years that end before the finalization date.

With respect to the reporting requirements for QDPs, Prop. Reg.  §1.6038A-2(b)(7)(ix) applies to taxable years beginning one year after final regulations are published in the Federal Register, although simplified QDP reporting requirements provided in Prop. Reg. §1.6038A-2(g) are also proposed to apply to taxable years beginning after December 31, 2017.

If any provision is finalized after June 22, 2019, the Treasury generally expects that such provision will apply only to taxable years ending on or after the date of filing in the Federal Register.
 

BDO Insights

The Proposed Regulations contain much need guidance on the BEAT, including guidance on the SCM exception.  There is a significant amount of complexity relating to the calculation of the BEAT.  A BDO international tax specialist can help you with applying the rules contained in the Proposed Regulations.