Part III: Moving to the BEAT
Don’t look now, but there’s a new minimum tax for U.S. corporations

The Tax Cuts and Jobs Act of 2017 brought about the most sweeping U.S. international tax reforms in the past 30 years.¹ One of those reforms was the base erosion and anti-abuse tax, which is also known as the BEAT.² The BEAT is intended to prevent large U.S. corporations from using deductible payments made to foreign related parties to base-erode their U.S. corporate tax liability. The BEAT specifically targets payments such as interest, royalties, and high-margin service payments to foreign related parties that could be used to shift profits outside of the United States. In this article, we examine the statutory framework of the BEAT as well as how the Internal Revenue Service proposes to address some of the ambiguities contained in the BEAT statute.

The BEAT Basics

The BEAT is a minimum tax, calculated as ten percent (five percent for 2018)³ multiplied by the taxpayer’s modified taxable income.⁴ If that result is greater than the taxpayer’s regular tax minus the credit adjustment, then that excess must be paid in as BEAT.⁵ The credit adjustment is all credits other than research credits, plus a portion of certain other credits.⁶ For example, foreign tax credits would reduce the regular tax liability, which could increase the amount of BEAT owed, whereas research and low-income credits are neutral. In formulaic terms, the BEAT is calculated as follows:

BEAT Liability = (BEAT Tax Rate x Modified Taxable Income) – (Taxpayer’s Regular Tax Liability – Credit Adjustment)

The taxpayer is subject to BEAT liability only if the first part of the equation is greater than the second part.

Modified taxable income equals taxable income plus “base erosion tax benefits.”⁷ Base erosion tax benefits are the deductions allowed by the Internal Revenue Code for the taxable year with respect to the base erosion payments.⁸ Base erosion payments are amounts paid or accrued to a foreign related person⁹ and with respect to which a deduction is allowable either immediately or eventually in the form of depreciation.¹⁰ For example, an amount paid to a foreign related person to purchase depreciable equipment is a “base erosion payment,” while the eventual depreciation on that equipment is a “base erosion tax benefit” for the taxable year in which the depreciation is allowed.

Modified taxable income is also increased for the “base erosion percentage” of any net operating losses (NOLs) from prior taxable years beginning in 2018 or after.¹¹ The base erosion percentage is calculated for the taxable year in which the NOL arose and is the aggregate amount of the taxpayer’s base erosion tax benefits divided by the sum of the aggregate amount of deductions plus certain reinsurance and inversion-related base erosion tax benefits.¹² This means that taxpayers must keep track of base erosion payments in taxable years that give rise to NOLs even if no BEAT is owed for that year. There is no haircut for NOLs arising in pre-2018 taxable years, since the base erosion percentage for those years is zero.¹³

Select BEAT Issues

The statutory language of the BEAT contains ambiguities and inconsistencies that have led to significant uncertainty for taxpayers in determining their BEAT liability. Some of these uncertainties are addressed in proposed Treasury regulations that were released on December 13, 2018.¹⁴ While these proposed BEAT regulations have not been finalized, the U.S. Treasury Department intends the final version of these regulations to apply retroactively to taxable years beginning after December 31, 2017.¹⁵ In addition, the U.S. Treasury Department provides that taxpayers may rely on the proposed BEAT regulations so long as they consistently apply the proposed rules for all taxable years before the finalization date.¹⁶ A selection of BEAT issues that are important to multinational companies and their determination of BEAT liability that have been addressed by the proposed BEAT regulations are discussed below.

Services Cost Method Exception

Base erosion payments would not include payments for services from related parties if the service payments are eligible for the services cost method (SCM) under Section 482 of the Code without application of the business judgment rule.¹⁷ The SCM allows a taxpayer to charge out certain services at cost, with no cost markup. Services eligible for SCM treatment must not be “excluded activities” under the list contained in Treasury Regulations Section 1.482-9(b)(4).¹⁸ In addition, the services must fall within one of two categories. The first category consists of specified covered services identified in Revenue Procedure 2007–13, generally consisting of tax, accounting, human resources, and other general administrative services.¹⁹ The second category consists of low-margin covered services, which are controlled services transactions that have a median comparable markup on total services costs that is seven percent or less.²⁰

One ambiguity in the BEAT statute is whether the inclusion of a cost markup on an outbound services payment taints the entire payment for purposes of applying the SCM exception. The ambiguity arises because Section 59A(d)(5) of the Code provides that a base erosion payment does not include any amount paid or accrued by the taxpayer for services if such amount “constitutes the total services cost with no markup component.” To illustrate this ambiguity, consider the scenario where a foreign affiliate of a U.S. corporation provides back-office support services for the U.S. corporation at a cost of $100 plus a $5 markup. The BEAT statute is ambiguous about how much of the $105 payment is a base erosion payment. Some practitioners have interpreted the BEAT statute to include the entire $105 as a base erosion payment, because the payment includes a markup component of $5. Fortunately, the proposed BEAT regulations clarify that only the $5 markup component would be a base erosion payment.²¹

As a result, U.S. corporations that make payments to foreign related parties for services should evaluate whether such payments are eligible for the SCM exception in the BEAT statute. As illustrated above, the SCM exception can apply to the cost portion of the services charges even if such charges include a cost markup.

Cost of Goods Sold Exception

Base erosion payments generally do not include payments that may reduce taxable income but are not treated as deductions, such as the cost of goods sold.²² Therefore, taxpayers may benefit for BEAT purposes if they can capitalize costs in the cost of goods sold under the uniform capitalization rules provided in Section 263A of the Code. That provision contains specific rules for when certain direct and indirect costs can be capitalized. The preamble to the proposed BEAT regulations explains that the regulations do not include specific rules for determining whether a payment to a foreign related party is treated as deductible or as an amount that reduces gross receipts.²³ Rather, general federal U.S. tax principles apply for making that determination.²⁴ Consequently, taxpayers will want to take a hard look at whether royalties or interest paid to foreign related parties can be capitalized to inventory.

In formulaic terms, the BEAT is calculated as follows:

BEAT Liability = (BEAT Tax Rate x Modified Taxable Income) – (Taxpayer’s Regular Tax Liability – Credit Adjustment)

The taxpayer is subject to BEAT liability only if the first part of the equation is greater than the second part.

Payment Netting

The BEAT statute does not expressly allow a taxpayer to net its inbound and outbound payments that are of a similar character. Multinational companies with cross-border transactions commonly net their gross outbound and inbound payments for business reasons. For example, cross-border payments are frequently netted and cash is settled on a monthly basis to minimize wire transfers and ease the administrative burdens of reconciling intercompany account balances and charges between the U.S. corporation and the foreign related party. Practitioners have suggested that a taxpayer should be able to reduce its base erosion payments by netting outbound and inbound payments of a similar character, because erosion of the U.S. tax base is lessened to the extent of the inbound payment. Unfortunately, the proposed BEAT regulations do not allow taxpayers to use payment netting for BEAT purposes.²⁵ The preamble to the proposed BEAT regulations mentions that payment netting is allowed if it is specifically permitted by other sections of the Code.²⁶

Payments That Consist of Noncash Consideration

The BEAT statute broadly defines base erosion payments as amounts paid or accrued to a foreign related person and with respect to which a deduction is allowable.²⁷ The proposed BEAT regulations treat the use of noncash consideration, including stock or the assumption of a liability, as an amount “paid or accrued” for BEAT purposes.²⁸ Thus, the actual or deemed exchange of stock in a tax-free acquisition of depreciable property can result in base erosion payments. For example, assume that a U.S. parent owns 100 percent of a controlled foreign corporation (CFC) and decides to liquidate that company under Section 332. There is a deemed exchange of stock for depreciable property, and any depreciation subsequently taken on that property is treated as a base erosion tax benefit.²⁹ The same would apply to inbound F or D reorganizations. This is both a trap for the unwary and seems like regulatory overreach—there is no shifting of income to a foreign jurisdiction to cause base erosion.³⁰ Indeed, in some cases, the movement of a foreign business into the U.S. would even enhance the U.S. tax base.

Anti-Abuse Rules

The BEAT statute grants the Treasury Secretary authority to issue regulations to prevent the avoidance of the BEAT through the use of unrelated persons, conduit transactions, or other intermediaries.³¹ The proposed BEAT regulations provide three anti-abuse rules that permit the Service to disregard a transaction (or series of transactions), plan, or arrangement that has the principal purpose of avoiding the BEAT.³² The first anti-abuse rule allows the Service to disregard transactions where intermediaries act as a conduit for the taxpayer to avoid a base erosion payment.³³ The second anti-abuse rule allows the Service to disregard transactions entered into by the taxpayer to increase the deductions taken into account for purposes of the denominator of the base erosion percentage computation.³⁴ The third anti-abuse rule allows the Service to disregard transactions entered into among related parties to avoid the rules applicable to certain banks and registered securities dealers.³⁵

Exceptions to the BEAT Rules

The BEAT applies only if the taxpayer has 1) annual gross receipts of at least $500 million for the three-year period ending with the preceding taxable year and 2) a base erosion percentage of three percent or higher.³⁶ In addition, payments that are subject to full or partial withholding under Code Section 1441 are not treated as base erosion payments to the extent of such withholding.³⁷ Also, practitioners have been concerned that payments to related parties that are effectively connected with a U.S. trade or business would be treated as base erosion payments, potentially causing double tax. The proposed regulations do provide an exception for income actually taxed as effectively connected income in those cases.³⁸ On the other hand, the proposed regulations provide no relief for base erosion payments that are included in Subpart F or global intangible low-taxed income (GILTI), unlike the anti-hybrid regulations.³⁹

BEAT Planning

Taxpayers may be able to minimize their BEAT exposure in several ways. In many cases, taxpayers will take a look at capitalizing royalties and payments for R&D services to inventory. In borderline cases, taxpayers could review whether it is possible to manage gross receipts to below the $500 million threshold or manage the base erosion percentage to below the three percent threshold. Taxpayers could eliminate or reduce certain base erosion payments by transacting with third parties rather than with foreign related parties, although these cannot be intermediaries for related parties. Taxpayers should also closely evaluate whether their outbound payments to foreign related parties qualify for the SCM exception discussed above. Another solution might be to have the U.S. corporation elect to check the box on its foreign related affiliate so that any outbound payment to the affiliate is considered a disregarded transaction. The check-the-box approach is low-impact from a legal and operational perspective, but may have other tax consequences. Finally, taxpayers with robust foreign tax credits might wish to evaluate the “high-tax exception” whereby tested income is kicked out of the GILTI regime and qualifies for the dividends-received deduction under Section 245A of the Code. This would increase the regular tax for purposes of calculating the BEAT.⁴⁰

Conclusion

Although the BEAT statute has created significant uncertainty for many multinational companies, the proposed BEAT regulations are helpful in addressing some of the issues that have caused taxpayers’ uncertainty. Time will tell if the U.S. Treasury Department and the IRS will provide a more comprehensive set of final BEAT regulations. In the meantime, large multinational companies with U.S. operations should monitor and manage their BEAT exposure.

Sam K. Kaywood is a partner at Alston & Bird in Atlanta, and Ryan J. Kelly is a partner at Alston & Bird in Washington, D.C.

Endnotes

1. Pub. L. No. 115-97, 131 Stat. 2054 (December 22, 2017).
2. See Internal Revenue Code (I.R.C. or the “Code”) Section 59A.
3. The BEAT tax rate is five percent for 2018 and ten percent for taxable years beginning in 2019 through 2025, and then increases to 12.5 percent in 2026 and thereafter.
4. I.R.C. Section 59A(b)(1).
5. I.R.C. Section 59A(b)(1). Further, Section 59A(c)(1) of the Code provides that modified taxable income is calculated without regard to any base erosion tax benefit or the base erosion percentage of any net operating loss deduction allowed under Section 172 for the taxable year.
6. The credits that reduce regular tax for BEAT purposes are research credits and the lesser of eighty percent of 1) low-income credits, renewable electricity credits, and investment credits, and 2) BEAT without regard to the credit adjustment. I.R.C. Sections 59A(b)(1)(B)(ii) and (b)(4).
7. I.R.C. Section 59A(c)(1).
8. I.R.C. Section 59A(c)(2).
9. I.R.C. Section 59A(g) broadly defines related parties. That provision defines a related party as: 1) any twenty-five-percent owner of the taxpayer; 2) any person who is related within the meaning of Code Section 267(b) or Code Section 707(b)(1) to the taxpayer or any twenty-five-percent owner of the taxpayer; and 3) any other person who is related within the meaning of Code Section 482 to the taxpayer.
10. I.R.C. Sections 59A(d)(1) and (2). Base erosion payments also include certain reinsurance premium paid or accrued to a related foreign person and any amount paid or accrued to a related inverted entity. I.R.C. Sections 59A(c)(3) and (4).
11. Prop. Treas. Reg. Section 1.59A-4(b)(2)(ii).
12. I.R.C. Section 59A(c)(4). For purposes of calculating the denominator of this percentage, one must ignore any NOL carried to the taxable year in which the base erosion percentage is being calculated; or any deductions under Code Section 245A (i.e., for a dividends received deduction) or Code Section 250 (relating to global intangible low-taxed income [GILTI] and foreign-derived intangible income).
13. Prop. Treas. Reg. Section 1.59A-4(b)(2)(ii).
14. See REG-104529-18.
15. Preamble to Prop. Treas. Reg. Section 1.59A at 73.
16. Id.
17. I.R.C. Section 59A(d)(5).
18. Excluded activities under Treas. Reg. Section 1.482-9(b)(4) are: 1) manufacturing; 2) production; 3) extraction, exploration, or processing of natural resources; 4) construction; 5) reselling, distribution, acting as a sales or purchasing agent, or acting under a commission or other similar arrangement; 6) research, development, or experimentation; 7) engineering or scientific; 8) financial transactions, including guarantees; 9) insurance and reinsurance.
19. See Treas. Reg. Section 1.482-9(b)(3)(i). Revenue Procedure 2007-13 sets forth a list of 101 specified covered services determined by the IRS to not require a significant cost markup on total services costs. The general categories of services that are considered specified covered services and eligible for SCM treatment include: 1) payroll; 2) premiums for unemployment, disability, and workers compensation; 3) accounts receivable; 4) accounts payable; 5) general administrative; 6) corporate and public relations; 7) meeting coordination and travel planning; 8) accounting and auditing; 9) tax; 10) health, safety, environmental, and regulatory affairs; 11) budgeting; 12) treasury activities; 13) statistical assistance; 14) staffing and recruiting; 15) training and employee development; 16) benefits; 17) IT services; 18) legal services; 19) insurance claims management; and 20) purchasing.
20. Treas. Reg. Section 1.482-9(b)(3)(ii).
21. Prop. Treas. Reg. Section 1.59A-3(b)(3)(i).
22. I.R.C. Section 59A(c)(2)(A)(iv); see also U.S. Congress, Joint Committee of Conference, 528 (Dec. 18, 2017) (stating “base erosion payments do not include payments for cost of goods sold (which is not a deduction but rather a reduction to income)).
23. Preamble to Prop. Treas. Reg. Section 1.59A at 19-20.
24. Id.
25. Preamble to Prop. Treas. Reg. Section 1.59A at 60.
26. Id.
27. I.R.C. Section 59A(d).
28. Prop. Treas. Reg. Section 1.59A-3(b)(2)(i).
29. Preamble to Prop. Treas. Reg. Section 1.59A at 20-21.
30. Id. Note that there are other protections in place to prevent the importation of property with built-in-losses, as Code Section 362(e) would step down the basis of that property in an inbound Code section 351 transaction or tax-free reorganization.
31. I.R.C. Section 59A(i).
32. Prop. Treas. Reg. Section 1.59A-9.
33. Prop. Treas. Reg. Section 1.59A-9(b)(1).
34. Prop. Treas. Reg. Section 1.59A-9(b)(2).
35. Prop. Treas. Reg. Section 1.59A-9(b)(3).
36. I.R.C. Section 59A(e)(1). The three-percent threshold is lowered to two percent for a taxpayer that is a bank or registered securities dealer. In addition, the BEAT does not apply to corporations that are regulated investment companies, real estate investment trusts, or S corporations.
37. I.R.C. Section 59A(d); Prop. Treas. Reg. Sections 1.59A-3(c)(2) and (3).
38. Prop. Treas. Reg. Section 1.59A-3(b)(3)(iii).
39. Prop. Treas. Reg. Sections 1.267A-3(b)(3) and (4).
40. For example, the taxpayer can affirmatively plan its way into the Subpart F regime such that high-taxed income qualifies for the high-tax exception. See I.R.C. Sections 951A(c)(2)(A)(i)(III) and 954(b)(4). This requires an effective foreign tax rate of at least 18.9 percent.