Final and Proposed Rules Issued on Base Erosion and Anti-Abuse Tax

| 2/13/2020
Final and Proposed Rules Issued on Base Erosion and Anti-Abuse Tax

On Dec. 6, the U.S. Department of the Treasury and the IRS published final and proposed regulations under IRC Section 59A. The regulations, titled the base erosion and anti-abuse tax (BEAT), are designed to discourage U.S. multinationals from moving profits offshore.

Background

The 2017 tax overhaul brought many changes for multinational companies. One of these changes was the BEAT, an alternative tax system aimed at minimizing the ability of U.S. taxpayers to obtain deductions for certain deductible payments made to non-U.S. related parties. Under this regime, deductible payments made to non-U.S. related parties are referred to as base erosion payments. A company is subject to the BEAT for a given tax year if 1) its base erosion percentage (ratio of base erosion payments for the year to total deductible payments for the year) exceeds 3%, and 2) the company has substantial gross receipts for the tax year qualifying it as an applicable taxpayer. For purposes of the BEAT, gross receipts and the base erosion percentage are determined on an aggregate U.S. basis, which looks at all related parties that would be considered a single U.S. employer.

Companies subject to the BEAT calculate a 10% tax (the BEAT rate) on modified taxable income (MTI). MTI is taxable income increased by base erosion payments. A company is liable for the BEAT to the extent it exceeds its regular tax liability (the company’s tax liability without taking into account the BEAT) for the tax year. The BEAT rate increases to 12.5% after 2025.

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Final regulations

The final regulations generally adopt the proposed regulations that were issued on Dec. 13, 2018, with certain revisions and clarifications made largely in response to public comments.

One comment suggested a change to the application of the aggregate method when U.S. group members have different tax years. The 2018 proposed regulations required all aggregation of U.S.-affiliated group members to be based on the affected taxpayer’s tax year. The affected taxpayer is the taxpayer whose attributes are being tested to determine its BEAT. The final regulations adopt the “with-or-within method,” which requires affected taxpayers to determine the group’s aggregate gross receipts and base erosion percentage based on the taxpayer’s tax year for the taxpayer’s contribution to those components and based on the tax years of any other U.S.-affiliated group member’s tax year that ends with or within the affected taxpayer’s tax year. Components attributable to a tax year of a member of the aggregate group that begins before Jan. 1, 2018, are excluded.

The definition of base erosion payments has been modified to clarify that payments for depreciable assets that will result in a reduction to gross income (increases to cost of goods sold, for example) are not treated as base erosion payments. The final regulations also exclude losses on property sold or transferred in satisfaction of an obligation to a foreign related party from the definition of a base erosion payment. In addition, the final regulations do not adopt the provision in the proposed regulations treating certain noncash payments in nonrecognition transactions, such as 351 contributions or 332 liquidations, as base erosion payments. However, anti-abuse rules may apply where the basis of transferred property is stepped up within six months of the transfer.

The final regulations apply to tax years ending on or after Dec. 31, 2018, but may be relied on for tax years ending after Dec. 31, 2017.

Proposed regulations

Proposed regulations were released on the same day as the final regulations. The proposed regulations allow taxpayers to make an annual election to waive certain deductions for base erosion payments for the tax year in the determination of regular tax liability. The waived base erosion payments do not increase MTI in the calculation of BEAT, thereby reducing the taxpayer’s BEAT liability. Once waived, these deductions may not be claimed for any U.S. federal income tax purpose, and detailed disclosure of the amount of the deduction waived is required. Taxpayers can file an amended return to increase the amount of the deductions waived under the election but cannot reduce the amount covered by an election or revoke an election via an amended return.

The proposed regulations also provide additional clarification regarding the application of the with-or-within method to the determination of gross receipts and base erosion percentage in the aggregate.

Taxpayers can rely on the proposed regulations for tax years ending after Dec. 31, 2017, and before Dec. 6, 2019, provided taxpayers apply the proposed regulations in their entirety. This provides taxpayers who were subject to the BEAT in 2018 the opportunity to amend their 2018 tax returns to make the election to waive deductions. However, taxpayers should consult with their tax advisers to evaluate the effect of applying the proposed regulations in their entirety before amending their returns to make this election.

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