IRS Clarifies Application of Services Cost Method Exception to BEAT

The IRS recently clarified that taxpayers may benefit from the services cost method (SCM) exception to the base erosion and anti-abuse tax (BEAT) even if they don’t apply the SCM for transfer pricing purposes.

Under the Tax Cuts and Jobs Act (TCJA) of 2017, certain outbound intercompany payments may be subject to the BEAT. The TCJA provided an exclusion, however, for the “cost component” of outbound payments for some services. This exclusion is based on the services cost method (SCM) under Reg. §1.482-9 but differs from those rules in important ways.

After a brief description of the SCM and BEAT, a discussion of important considerations for application of the SCM exception, including how the SCM rules for BEAT differ from those used for transfer pricing purposes, follows.  

Services Cost Method

The IRS introduced the SCM to simplify the transfer pricing of some controlled services transactions and reduce taxpayers’ compliance burden regarding routine intercompany services. 

Under Reg. §1.482-9 (b)(1), the SCM “evaluates whether the amount charged for certain services is arm’s length by reference to the total services costs . . . with no markup.” 

To be eligible for the SCM, a service must meet several requirements listed in Reg. §1.482-9(b)(2):

• It must be a “covered service”;
• It may not be a specifically excluded activity;
• It is not excluded from SCM under the “business judgment rule” as a service related to competitive advantages, core capabilities, or fundamental risks of success or failure; and
• It must be substantiated in books and records adequately maintained by the taxpayer.

Covered services include two categories: specified covered services and low-margin covered services. Specified covered services, in turn, are controlled services transactions that the IRS has specified in Rev. Proc. 2007-13. “Low margin covered services” are controlled services transactions for which the median comparable markup on total services costs is no greater than 7%.

Rev. Proc. 2007-13 lists 101 activities as eligible for treatment as specified covered services, grouped under categories including, for example, payroll, administrative, meeting coordination, accounting, staffing and recruiting, information and technology services, and legal services. These are often referred to as “white list” services. 

Reg. §1.482-9(b)(4) defines the following types of activities as activities excluded from the SCM (often referred to as “black list” services):

• Manufacturing
• Production
• Extraction, exploration, or processing of natural resources
• Construction
• Reselling, distribution, acting as a sales or purchasing agent, or acting under a commission or other similar arrangement
• Research, development, or experimentation
• Engineering or scientific activities
• Financial transactions, including guarantees
• Insurance or reinsurance

The business judgment rule limits the SCM to services that do not “contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure in one or more trades or businesses of the controlled group.”  Reg. §1.482- 9(b)(5).

BEAT

The BEAT was introduced by the TCJA as Section 59A of the Internal Revenue Code to combat tax practices whereby multinational enterprises (MNEs) erode their U.S. taxable income by shifting profits to overseas entities.

The BEAT is a minimum tax that applies to MNEs that had at least $500 million in average annual gross receipts for the previous three years, make “base erosion payments” to foreign related parties, and had a “base erosion percentage” for the taxable year of greater than or equal to 3% (2% for some taxpayers, including banks). The base erosion percentage is generally calculated by dividing the aggregate amount of the taxpayer’s “base erosion tax benefits” – or deductions attributable to base erosion payments – by the total amount of the taxpayer’s deductions for the year. 

The definition of “base erosion payments” is broad and includes “any amount paid or accrued by the taxpayer to a [foreign related party] and with respect to which a deduction is allowable under this chapter.”

However, the BEAT regulations provide an exception from inclusion in the base erosion payment calculation for some outbound intercompany payments for certain intercompany services provided by non-U.S. related parties. This exception offers a significant opportunity to reduce a taxpayer’s BEAT exposure.

To apply the SCM exception, all the requirements of Treas. Reg. 1.482-9(b) listed above must be satisfied, except the business judgment rule under Reg. 1.482-9(b)(5). Moreover, adequate books and records must be maintained in accordance with the rules under Reg. §1.59A-3(b)(i)(C), instead of Reg. §1.482-9(b)(6).

If the SCM exception is applied to a transaction that is priced as cost plus a markup, only the cost component can be excluded from BEAT. In other words, the markup component is subject to BEAT.

IRS Guidance on SCM Exception to BEAT

The U.S. is the only country that has enacted the SCM. Most non-U.S. entities price intragroup services using the transactional net margin method (TNMM), whereby the value of services equals the cost of providing those services plus an arm’s length markup, or the “low value-adding services” method, whereby the value of services equals the cost of providing those services plus a 5% markup. After passage of the TCJA, it was unclear to some taxpayers if the BEAT SCM exception could apply to transactions that included a markup component or if the SCM was not selected as the most appropriate transfer pricing method.

In a Chief Counsel Advise memorandum (ILM 202529008) dated June 6, 2025, and released on July 18, 2025, the IRS clarified that taxpayers may benefit from the SCM exception to the BEAT even if they don’t apply the SCM for transfer pricing purposes. The memo reiterates that neither the BEAT statute nor the regulations thereunder require that services must meet the business judgement rule for taxpayers to apply the SCM exception.

The memo relies on the BEAT regulations to bolster its conclusion, noting that those regulations recognize that the BEAT exception differs from the SCM. Reg. §1.59A-3(b)(3)(i)(A) provides that “any amount paid or accrued to a foreign related party in excess of the total services cost of services eligible for the services cost method exception (the mark-up component) remains a base erosion payment.” By stating that the Section 59A SCM exception covers transactions even if the amounts paid for services exceed costs, Treas. Reg. §1.59A-3(b)(3)(i) “clearly contemplates” that the BEAT SCM exception applies to transactions not priced under the SCM.

Documentation

Taxpayers should maintain documentation under IRC §6662(e) to avoid the potential imposition of penalties related to transfer pricing; however, the memo states that these records alone may not be sufficient to satisfy the BEAT SCM exception recordkeeping requirements. More specifically, the memo cites the regulations under Section 59A, which require records that document “the total amount of costs that are attributable to each of those services, the method chosen . . .  to apportion the costs between the service eligible for the services cost method under this section and the other service, and the application of that method in calculating the amount eligible for the . . .  services cost method exception.”