On December 2, 2019, the Treasury Department and the Internal Revenue Service (the “IRS”) issued final and proposed regulations (the “Final Regulations” and the “2019 Proposed Regulations,” respectively) regarding the base erosion and anti-abuse tax (generally referred to as the “BEAT”). The BEAT was introduced as part of the Tax Cuts and Jobs Act of 2017 (the “TCJA”) with the intended purpose of preventing U.S. corporations from unduly reducing their U.S. taxable income through payments to related foreign parties. While generally retaining most substantive features of the proposed regulations issued on December 13, 2018 (the “2018 Proposed Regulations”), the Final Regulations contain a number of meaningful clarifications and changes. Among the notable clarifications and changes in the Final Regulations and the 2019 Proposed Regulations are the addition of an election to waive deductions, the lack of an exception for payments subject to the subpart F or GILTI regimes, the addition of an exception for corporate nonrecognition transactions, and a clarification that payments under securities lending transactions generally qualify for the qualified derivative payment exception.
This note analyzes the BEAT and discusses the clarifications and changes made by the Final Regulations and the 2019 Proposed Regulations.
Part I – Taxpayers Subject to the BEAT: Applicable Taxpayers
The BEAT applies only to “applicable taxpayers.” An applicable taxpayer is a corporation (other than a RIC, a REIT, or an S corporation) that (together with its “aggregate group,” if applicable) satisfies the gross receipts test and the Base Erosion Percentage test, each as described below.
Aggregation of Taxpayers
For purposes of determining whether a corporation is an applicable taxpayer, corporations are aggregated into an “aggregate group” if they are treated as a single employer under section 52(a), with certain modifications. In general, corporations are aggregated for this purpose if they are related by 50% common ownership.
- The Final Regulations clarify that, even though RICs, REITs, and S corporations cannot be applicable taxpayers, RICs and REITs may be included in the aggregate group for purposes of applying the gross receipts test and the Base Erosion Percentage test.
- In addition, the Final Regulations do not include an exception that comments had requested from the aggregate group rules for foreign government shareholders of corporations.
Gross Receipts Test
A taxpayer satisfies the gross receipts test if the taxpayer (or the aggregate group of which it is a member) has $500 million or more of average annual gross receipts during the three prior taxable years. In the case of a foreign corporation, the gross receipts test only takes into account gross receipts that are taken into account in determining effectively connected income (“ECI”).
- When a bank originates and sells loans, the bank is required to include the gross proceeds from the sale of the loan in its gross receipts. If, however, the bank holds the loan to maturity, the proceeds received upon repayment are not included in gross proceeds. The Final Regulations declined to address this disparate treatment, but the preamble to the Final Regulations (the “Preamble”) notes that the government is continuing to study the issue.
Base Erosion Percentage Test
The Base Erosion Percentage test is satisfied with respect to a taxpayer if the taxpayer (or the aggregate group of which the taxpayer is a member) has a “Base Erosion Percentage” of 3% or more. The Base Erosion Percentage threshold is 2% (rather than 3%) if the taxpayer, or a member of the taxpayer’s aggregate group, is a member of an affiliated group that includes a domestic bank or registered securities dealer.
The Base Erosion Percentage for a taxable year is calculated by dividing:
- the aggregate amount of Base Erosion Tax Benefits (the “numerator”) by
- the sum of the aggregate amount of deductions plus certain other Base Erosion Tax Benefits (the “denominator”).
Base Erosion Tax Benefits generally are the deductions (or, in certain circumstances such as reinsurance payments or payments to a “surrogate foreign corporation,” reductions in gross income) that result from Base Erosion Payments. A detailed description of the items that are taken into account in calculating the numerator is set forth below in Part II and Part III.
- For aggregate groups in which the aggregate group members have different taxable years, the 2018 Proposed Regulations applied the gross receipts and Base Erosion Percentage tests by reference to the gross receipts, Base Erosion Tax Benefits and deductions in the taxpayer’s own taxable year and not another aggregate group member’s taxable year, if different.
- In response to concerns about administrative burdens, the Final Regulations apply the gross receipts and Base Erosion Percentage tests by reference to the gross receipts, Base Erosion Tax Benefits and deductions for the taxpayer’s taxable year and, for each member of the taxpayer’s aggregate group, the taxable year of the member that ends with or within the taxpayer’s taxable year (the “With-or-Within Rule”).
- The 2019 Proposed Regulations propose additional rules within the context of the With-or-Within Rule, including the treatment of short taxable years, members leaving and joining an aggregate group, members that deconsolidate from a consolidated group and join a different aggregate group, and predecessors of a taxpayer.
- The Final Regulations clarify that a transaction between parties is disregarded for purposes of the BEAT when determining the gross receipts and Base Erosion Percentage of an aggregate group only if both parties were members of the aggregate group at the time of the transaction, without regard to whether the parties were members of the aggregate group on the last day of the taxpayer’s taxable year.
- When determining the Base Erosion Percentage of an aggregate group, the Final Regulations exclude the Base Erosion Tax Benefits and deductions attributable to the taxable year of an aggregate group member that begins before January 1, 2018.
- In the case of transactions that are marked to market for tax purposes, the Final Regulations retain the rule in the 2018 Proposed Regulations that combines all income, deduction, gain, or loss on each transaction for the year to determine the amount of the deduction that is used for purposes of the Base Erosion Percentage test (the “Netting Rule”).
- As a result of the Netting Rule, if a taxpayer recognizes a mark-to-market loss with respect to a security, but took into account any income or gain items with respect to such security during the taxable year, the taxpayer must net all of such items in determining whether it has a deduction with respect to the security for the taxable year.
- The Final Regulations clarify that the Netting Rule is applicable to all positions that are marked to market for tax purposes (including physical positions) and that the rule is not elective.
- The Final Regulations include any losses from section 988 transactions in the denominator of the Base Erosion Percentage except to the extent such section 988 losses are from foreign related party transactions that are also excluded from the numerator of the Base Erosion Percentage. This is an important change from the 2018 Proposed Regulations, which would have excluded all losses from section 988 transactions from the Base Erosion Percentage denominator.
Election to Waive Allowable Deductions
The 2019 Proposed Regulations provide that a taxpayer may forego a deduction and that such foregone deduction will not be treated as a Base Erosion Tax Benefit if the taxpayer waives the deduction for all U.S. federal income tax purposes and follows specified procedures.
Important Notes About the Election
- A taxpayer may make the election to waive deductions on its original tax return, an amended return, or during the course of an examination of the taxpayer’s tax return.
- The election is made separately for each taxable year, and thus taxpayers do not need the consent of the IRS to choose not to make the election in a subsequent year for the same type of item.
- By making an election to waive deductions, a taxpayer agrees that if a change in method of accounting is made with respect to an item that has been waived, the previously waived portion of the item is not taken into account in determining the amount of adjustment under section 481(a).
- To make the election, a taxpayer must provide detailed information to the IRS about the waived deduction(s).
- The availability of this deduction is helpful, particularly for taxpayers who have a Base Erosion Percentage slightly above the relevant threshold, because it allows taxpayers to reduce their Base Erosion Percentage and thus potentially avoid treatment as an applicable taxpayer.
- As described in Part IX below, taxpayers may rely on the 2019 Proposed Regulations prior to when they are finalized, including the election to forego a deduction.
Part II – Base Erosion Payments
General Definition of Base Erosion Payments
The Regulations define a “Base Erosion Payment” as a payment or accrual by the taxpayer to a “foreign related party” that is described in one of four categories:
- a payment with respect to which a deduction is allowable,
- a payment made in connection with the acquisition of depreciable or amortizable property,
- 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
- 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.
For purposes of the BEAT rules, the term “related party” means:1
- any 25% owner of the taxpayer, by vote or value,
- any person who is related, as defined in section 267(b) or 707(b)(1), to the taxpayer or to a 25% owner of the taxpayer, and
- any person related to the taxpayer under section 482.
- The Final Regulations declined to provide exceptions for the following circumstances:
- The Final Regulations declined to provide a general exception to the definition of Base Erosion Payment in situations when the foreign related party receiving a payment also makes corresponding payments to unrelated persons. The Final Regulations also declined to provide exceptions for:
- payments to a foreign related party for manufacturing-related services or
- payments to foreign related parties that arise because of non-tax business considerations, such as non-tax foreign regulatory requirements.
- The Final Regulations do not provide express exceptions from the Base Erosion Payment definition for revenue sharing payments or arrangements, including allocations with respect to global dealing operations. However, the Preamble provides that the proper characterization of payments under such arrangements depends on the underlying facts and the relationships between the parties.
- Under the Final Regulations, the amount of any Base Erosion Payment is determined on a gross basis, except as provided by the Netting Rule or to the extent permitted under generally applicable federal income tax law.
- The Final Regulations do not adopt an exception to the definition of Base Erosion Payment for hedging payments made by domestic corporations to a hedging center that is a foreign related party.
- The Final Regulations do clarify, however, that whether a deductible payment is made to a foreign related party generally is determined under generally applicable U.S. tax principles, such as rules governing agency relationships and co-ownership status.
- The Final Regulations clarify that a loss realized from the sale of property to a foreign related party does not itself constitute a Base Erosion Payment. However, if a taxpayer uses built-in loss property to make a payment that would have been a Base Erosion Payment, the fair market value of the property is treated as the amount of the Base Erosion Payment.
- Finally, the government declined to adopt a proposal to include an exception to Base Erosion Payments for payments made by a domestic corporation to a controlled foreign corporation that result in a subpart F or global intangible low tax income inclusion or payments made to a passive foreign investment company for which a U.S. person has made a qualified electing fund election.
Exceptions from Treatment as Base Erosion Payments
Exception for Corporate Nonrecognition Transactions
The Final Regulations generally exclude from Base Erosion Payments any amount transferred to, or exchanged with, a foreign related party in a transaction described in section 332, 351 or 368 (i.e., a corporate nonrecognition transaction). However, the exception does not apply to the transfer of other property or money (i.e., “boot”) in connection with the transaction, including the assumption of liabilities to the extent of gain recognized under section 357(c).
- The Final Regulations add an anti-avoidance rule which would deny the benefit of the rule for nonrecognition transactions where a transaction (or series of transactions), plan or arrangement has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a corporate nonrecognition transaction. A step up in basis within six months of an acquisition of property in a corporate nonrecognition transaction is deemed to fall under the anti-avoidance rule.
- The Final Regulations also clarify that a distribution of property with respect to stock for which there is no consideration is not an amount paid or accrued by the shareholder to the corporation. A redemption of stock in exchange for property (such as a redemption described in section 302(a) and (d) or section 306(a)(2)) or an exchange of stock described in section 304 or section 331 is an amount paid or accrued by the shareholder to the corporation and thus may constitute a Base Erosion Payment.
Exception for Amounts Eligible for the Services Cost Method under Section 482
The term Base Erosion Payment does not include any amount paid or accrued by a taxpayer for services to the extent (A) the services are eligible for the services cost method (“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 Final Regulations do not extend the SCM exception to other types of services, such as research and experimentation services.
Exception for Qualified Derivative Payments
A payment constituting a qualified derivative payment (a “QDP”) is not a Base Erosion Payment. A QDP is defined as any payment made by a taxpayer to a foreign related party pursuant to a derivative if:
- the taxpayer recognizes gain or loss on the derivative on a mark-to-market basis,
- the gain or loss is ordinary,
- any gain, loss, income or deduction on a payment made pursuant to the derivative is also treated as ordinary, and
- the taxpayer satisfies new reporting requirement under section 6038A.
For this purpose, the term “derivative” is defined as any contract, the value of which, or any payment with respect to which, is determined by reference to any stock, evidence of indebtedness, actively traded commodity, currency, or any rate, price, amount, index, formula or algorithm.
- Like the 2018 Proposed Regulations, the Final Regulations provide that the term “derivative” does not include any sale-repurchase transaction or substantially similar transaction that is treated as a secured loan for U.S. federal income tax purposes.
- However, unlike the 2018 Proposed Regulations, the Final Regulations clarify that securities lending transactions are treated as consisting of two legs: (1) a loan of securities (the “Securities Leg”) and (2) a loan of cash (the “Cash Leg”). The Cash Leg of a securities lending transaction is excluded from the definition for derivatives (and thus may give rise to Base Erosion Payments). Payments made with respect to the Securities Leg of a securities lending transaction, such as a borrow fee, may qualify as a QDP. Since interest on the Cash Leg and any borrow fee with respect to the Securities Leg are often paid as a single net amount, it is not clear how or whether such payments should be disaggregated for purposes of this rule (or for tax purposes generally).
- The Final Regulations adopt an anti-abuse rule with respect to the application of the QDP rules to a securities lending transaction. That rule takes into account two factors: (a) whether the securities lending transaction or substantially similar transaction provides the taxpayer with the economic equivalent of a substantially unsecured cash borrowing and (b) whether the transaction is part of an arrangement that has been entered into with a principal purpose of avoiding the treatment of any payment with respect to the transaction as a Base Erosion Payment.
- Since positions with respect to which payments qualify as QDPs generally are excluded from treatment as Base Erosion Payments even where the positions are between related parties, the Netting Rule (discussed above in Part I) is unlikely to apply to payments with respect to derivative positions between related parties.
- With respect to the QDP reporting requirements:
- The Final Regulations clarify that, although the new reporting requirement under section 6038A is applicable only to a “reporting corporation” (i.e., a domestic corporation that is 25% foreign owned), all taxpayers must report under section 6038A in order to qualify for the QDP exception.
- The 2018 Proposed Regulations required reporting during the transition period of the aggregate amount of QDPs as determined by derivative contract, the identity of each counterparty, and the aggregate amount of QDPs made to each counterparty. The Final Regulations eliminate these requirements and instead require only reporting of the aggregate amount of QDPs.
- The Final Regulations extend the transition period for meeting the complete QDP reporting requirements until taxable years beginning on or after June 6, 2021.
Exception for Payments the Recipient of Which Treats as ECI
- The Final Regulations retain the rule from the 2018 Proposed Regulations that does not treat a payment to a foreign related party as a Base Erosion Payment to the extent that such payment is treated as ECI to the foreign related party (but only if the taxpayer receives a Form W-8ECI with respect to such payment).
- Despite numerous comments requesting expansion of this exception, no similar exception is provided for amounts paid to a controlled foreign corporation that are taken into account by a U.S. shareholder as subpart F or GILTI income.
Exception for Exchange Loss from a Section 988 Transaction
- As noted above, the Final Regulations provide that section 988 losses with respect to transactions with foreign related parties are not treated as Base Erosion Payments. However, for purposes of calculating the Base Erosion Percentage, section 988 losses with respect to transactions that are not with foreign related parties are included in the denominator.
Exception for Interest on TLAC Securities
The Federal Reserve requires that certain global systemically important banking organizations (“GSIBs”) issue “total loss-absorbing capacity” (“TLAC”) securities. In particular, a domestic intermediate holding company of a foreign GSIB is required to issue a minimum amount of internal TLAC securities to its foreign parent.
- The Final Regulations provide that interest paid pursuant to TLAC securities does not constitute Base Erosion Payments but only to the extent of the amount of interest paid on TLAC securities that the Federal Reserve requires to be issued, as adjusted by the Buffer Rule (discussed below).
- The Final Regulations expand the scope of the TLAC exception to include internal securities issued by GSIBs pursuant to laws of a foreign country that are comparable to the rules of the Federal Reserve (“Foreign TLAC”) where those securities are properly treated as debt for U.S. federal income tax purposes.
- Foreign TLAC securities of a U.S. branch or permanent establishment (a “PE”) eligible for the TLAC exception is limited by reference to the lesser of (1) the hypothetical minimum amount of TLAC securities that would be required by the Federal Reserve if the branch or PE were a domestic subsidiary subject to Federal Reserve requirements and (2) the minimum amount of TLAC securities that are required pursuant to the bank regulatory requirements of a foreign country that are comparable to the requirements established by the Federal Reserve. If the relevant foreign country does not specify a minimum amount of TLAC securities, the limitation is determined by reference to the hypothetical Federal Reserve limitation.
- Because the required amount of TLAC securities may vary over time and market issuances of TLAC securities require lead time, the Final Regulations provide that the limitation on TLAC and Foreign TLAC securities is 115% of the minimum amount of TLAC securities required (the “Buffer Rule”), which is intended to provide a “buffer” in instances where the amount of TLAC securities issued is more than that required by Federal Reserve requirements or comparable foreign requirements.
- The TLAC exception does not apply to securities issued pursuant to other regulatory requirements or to TLAC securities issued during the transition period before TLAC is required to be issued.
Special Rules for Determining Base Erosion Payments of a Foreign Corporation with a U.S. Trade or Business
Determination of the Amount of Interest Expense
For purposes of determining the amount of interest expense allocable to a foreign corporation’s ECI, the Final Regulations provide that the amount of U.S. branch interest expense treated as paid to a foreign related party is the sum of:
- the directly allocated interest expense that is paid or accrued to a foreign related party,
- the interest expense on U.S.-booked liabilities that is paid or accrued to a foreign related party, and
- the interest expense on U.S.-connected liabilities in excess of interest expense on U.S.-booked liabilities multiplied by the ratio of average foreign related party interest over average total interest.
- In contrast to the 2018 Proposed Regulations, the third step in the foregoing calculation uses a worldwide interest ratio rather than a worldwide liabilities ratio.
- The Final Regulations allow taxpayers to determine their worldwide interest ratio using applicable financial statements of the taxpayer (but not a consolidated financial statement).
- The Final Regulations decline to adopt a fixed ratio or safe harbor for the worldwide interest ratio.
Base Erosion Payments Attributable to Interest Allocated to a Permanent Establishment
For taxpayers who allocate interest to a PE under a tax treaty, the Final Regulations attempt to treat such interest in a manner consistent with the treatment of interest expense determined under Treas. Reg. § 1.882-5.
- The Final Regulations do this first by treating the “hypothetical” amount of interest expense that would have been allocated to the PE under Treas. Reg. § 1.882-5 (but not to exceed the amount of interest attributable to the PE under the treaty) in the same manner as interest determined under Treas. Reg. § 1.882-5 would have been treated under the rules described above.
- Interest expense in excess of the hypothetical Treas. Reg. § 1.882-5 interest expense is treated as interest expense paid by the PE to the home office or other branch of the foreign corporation and therefore is treated as a Base Erosion Payment.
Part III – Base Erosion Tax Benefits
The amount of an applicable taxpayer’s 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 (discussed in Part V below). A Base Erosion Tax Benefit generally is the amount of any deduction relating to a Base Erosion Payment that is allowed under the Code for the taxable year.
Withholding Tax on Payments
- The Final Regulations adopt the rules in the 2018 Proposed Regulations that state that (1) if withholding tax is imposed on a Base Erosion Payment (without reduction under an applicable income tax treaty), the Base Erosion Payment is treated as having a Base Erosion Tax Benefit of zero; and (2) if an income tax treaty reduces the amount of withholding imposed on the Base Erosion Payment, the Base Erosion Payment is excluded from Base Erosion Tax Benefit treatment on a proportionate basis based on the amount of withholding tax imposed.
- The Final Regulations reduce any Base Erosion Tax Benefit attributable to excess interest to the extent that tax is imposed on the foreign corporation under section 884(f) and Treas. Reg. § 1.884-4 and the tax is properly reported on the foreign corporation’s income tax return.
Interaction with the Interest Disallowance Provisions of Section 163(j)
Section 59A(c)(3) sets forth a stacking rule to address cases in which section 163(j) applies to disallow interest deductions of a taxpayer. Under this rule, the reduction in the amount of deductible interest under section 163(j) is treated as allocable first to interest paid or accrued to persons who are not related parties with respect to the taxpayer and then to related parties. This has the effect of maximizing the amount of interest potentially giving rise to Base Erosion Tax Benefits.
- The Final Regulations clarify that 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
- second, as business interest expense paid to unrelated parties.
- For purposes of such rule, business interest expense that is excluded from the definition of Base Erosion Payment under the TLAC exception or the exception for payments subject to withholding tax retains its classification as payments to foreign related parties, but the foreign related business interest expense of the taxpayer includes such excepted interest expense on a pro rata basis.
Part IV – Modified Taxable Income
Method of Computation
The Modified Taxable Income of a taxpayer equals the taxpayer’s taxable income for the taxable year, determined without regard to:
- Base Erosion Tax Benefits, and
- the Base Erosion Percentage of any NOL deduction.
- The Final Regulations confirm that the computation of Modified Taxable Income is done on an “add-back” basis rather than a “recomputation” or a “limited recomputation” approach. As a result, Modified Taxable Income is computed by starting with taxable income or loss as computed for regular tax purposes and adding to that amount (i) the gross amount of Base Erosion Tax Benefits for the taxable year and (ii) the Base Erosion Percentage of any NOL deduction.
Effect of Current Year Losses and Excess NOL Carryovers on Modified Taxable Income
One significant issue arising from the statutory BEAT provision was whether an applicable taxpayer’s taxable income, to be used as the starting point for calculating its Modified Taxable Income, could be negative as a result either of a current year net taxable loss or the application of NOL carryovers or carrybacks to the taxable year.
- The Final Regulations retain the rule from the 2018 Proposed Regulations that provides where there is an NOL deduction from an NOL carryover or carryback to the taxable year and that NOL deduction exceeds the amount of positive taxable income before that deduction, the excess amount of NOL deduction does not reduce taxable income below zero for purposes of determining the starting point for computing Modified Taxable Income.
- Where there is a current year net taxable loss, however, the examples in both the 2018 Proposed Regulations and the Final Regulations make clear that the starting point in computing Modified Taxable Income is the current year net taxable loss.
Determining the Base Erosion Percentage of NOL Deductions
As noted above, Modified Taxable Income includes the Base Erosion Percentage of any NOL deduction allowed under section 172 for the taxable year (the “NOL Add-back”).
- The Final Regulations adopt the rule in the 2018 Proposed Regulations providing that the Base Erosion Percentage to be applied in determining the NOL Add-back is the Base Erosion Percentage determined for the year in which the loss arose (which is referred to as the “vintage year”), rather than the Base Erosion Percentage for the year in which such NOLs are used.
- The Final Regulations confirm that in computing the NOL Add-back, the relevant Base Erosion Percentage is the Base Erosion Percentage for the aggregate group of which the applicable taxpayer is a member.
Part V – Base Erosion Minimum Tax Amount
An applicable taxpayer’s tax liability under the BEAT for any taxable year is referred to as its base erosion minimum tax amount (“BEMTA”), which equals the excess of (1) the applicable tax rate (the “BEAT tax rate”) multiplied by the taxpayer’s Modified Taxable Income over (2) the taxpayer’s adjusted regular tax liability, each as determined for that taxable year. In computing the taxpayer’s regular tax liability for a taxable year, certain credits (including foreign tax credits) generally are subtracted from the regular tax liability amount.
The BEAT tax rate for a taxable year generally is as follows:
- for taxable years beginning in 2018, 5%
- for taxable years beginning after December 31, 2018, through taxable years beginning before January 1, 2026, 10%, and
- for taxable years beginning after December 31, 2025, 12.5%.
As described in Part VII below, the BEAT tax rate is increased by 1% for a taxpayer that is a member of an affiliated group that includes a bank or registered securities dealer.
- The Final Regulations clarify that BEMTA is calculated on a taxpayer-by-taxpayer basis rather than with respect to the aggregate group.
- The Final Regulations provide that NOL carryovers that arose in taxable years beginning before January 1, 2018, are excluded from the calculation of modified taxable income.
- Under the Final Regulations, credits for the alternative minimum tax are excluded from the calculation of credits that reduce adjusted regular tax liability in the BEMTA calculation. In effect, this reduces the BEMTA that a taxpayer is required to pay.
- The Final Regulations clarify that for taxpayers who use a taxable year other than the calendar year, section 15 (which applies a blended rate based on the rates applicable before and after the effective date of a rate change) does not apply to the change in rate effective December 31, 2018 (but section 15 does apply to the change in rate effective December 31, 2025). Taxpayers therefore will not be required to apply a blended rate for taxable years that begin in 2018 and end after December 31, 2018.
Part VI – Application of the BEAT to Partnerships
Only corporations can be “applicable taxpayers.” Thus, a partnership is not an applicable taxpayer.
- The Final Regulations retain the aggregate approach in the 2018 Proposed Regulations that treat a partnership as an aggregate of its partners in determining whether payments to or from a partnership are Base Erosion Payments.
- Specifically, when determining whether a payment constitutes a Base Erosion Payment:
- amounts paid or accrued by a partnership are treated as paid or accrued by such partner to the extent such amounts are properly allocated to the partner;
- amounts received or accrued by a partnership are treated as received or accrued by a partner for such purpose to the extent such amounts are properly allocated to such partner; and
- contributions of property to a partnership in exchange for the issuance of a partnership interest is treated by the contributing partner as an exchange of:
- a portion of the contributed property and the assumption of any liabilities associated with the transferred partnership interest, for
- a portion of the partners’ pre-contribution interests in the partnership’s assets and the partners’ assumption of any liabilities transferred to the partnership.
- In addition, if a distribution of property from a partnership to a partner causes an increase in the tax basis of property that either the partnership continues to hold or the partnership distributes to a partner, Base Erosion Payment is determined by treating the increase in tax basis for the benefit of a taxpayer that is attributable to a foreign related party as if it was property newly purchased by the taxpayer from the foreign related party and placed in service when the distribution occurs.
- Notably, although the Final Regulations provide an exception for payments made pursuant to a corporate nonrecognition transaction, there is not a similar exception for payments made in partnership nonrecognition transactions (such as contributions governed by section 721).
- The Final Regulations also retain the small interest exception to the aggregate approach introduced in the 2018 Proposed Regulations for purposes of determining Base Erosion Tax Benefits from a partnership. Under this exception, a partner is not required to take into account its proportionate share of Base Erosion Tax Benefits with respect to a partnership if (after taking into account direct, indirect, and constructive ownership):
- such partner’s partnership interest represents at all times during the taxable year less than 10% of the capital and profits of the partnership,
- the partner is allocated less than 10% of each partnership item of income, gain, loss, deduction, and credit for the taxable year, and
- such partner’s partnership interest has a fair market value of less than $25 million on the last day of the taxable year.
Part VII – Rules Relating to Groups That Include Banks and Registered Securities Dealers
The BEAT statutory provision provides special rules for certain groups that include a bank or registered securities dealer (a “Financial Group”). Specifically:
- the Base Erosion Percentage threshold for entities within a Financial Group is 2% (rather than 3%), and
- the BEAT tax rate is one percentage point higher for members of a Financial Group (i.e., 6% for taxable years beginning in 2018, 11% for taxable years beginning after December 31, 2018, through taxable years beginning before January 1, 2026, and 13.5% for taxable years beginning after December 31, 2025, rather than 5%, 10%, and 12.5%, respectively).
- The Final Regulations retain the limited exception from Financial Group treatment in the 2018 Proposed Regulations for purposes of the Base Erosion Percentage threshold for members of an affiliated group that includes a bank or registered securities dealer where the activities of the bank or registered securities dealer are de minimis (i.e., generally where the gross receipts attributable to the bank or the registered securities dealer are less than 2% of the group’s gross revenues).
- The Final Regulations additionally provide that the one percentage point added to the BEAT tax rate is not applicable to a taxpayer that is part of an affiliated group that qualifies for the de minimis exception.
- The Final Regulations do not adopt an exception for transitory ownership of a bank or securities dealer, and the Final Regulations confirm that the Base Erosion Percentage threshold applies to the entire aggregate group and not just the affiliated group that includes a bank or registered securities dealer.
Part VIII – Anti-Abuse Rules
The TCJA authorized the Secretary to prescribe regulations as may be necessary or appropriate to carry out the provisions of the BEAT, including regulations necessary to prevent the avoidance of the purposes of the BEAT through the use of unrelated persons, conduit transactions, or other intermediaries.
- The 2018 Proposed Regulations provided three specific anti-avoidance rules that may alter the BEAT consequences of the following transactions that have a “principal purpose” of avoiding the BEAT:
- in the case of transactions involving intermediaries acting as a conduit to avoid the treatment of a payment as a Base Erosion Payment, the role of the intermediary may be disregarded or the payment to the intermediary may be treated as a Base Erosion Payment,
- transactions entered into to increase the deductions taken into account in the denominator of the Base Erosion Percentage are disregarded for purposes of the Base Erosion Percentage calculation, and
- transactions among related parties entered into to avoid the application of rules applicable to banks and registered securities dealers (such as transactions to disaffiliate a bank or securities dealer) are disregarded.
- The Final Regulations adopt the 2018 Proposed Regulations anti-avoidance rules without significant modification and add the anti-avoidance rules for corporate nonrecognition transactions (discussed in Part II above) and for securities lending transactions (discussed in Part II above).
Part IX – Effective Date
The Final Regulations (other than the reporting requirements for QDPs under section 6038A) apply to taxable years ending on or after December 17, 2018. However, a taxpayer may apply the Final Regulations to taxable years beginning after December 31, 2017, and ending before December 17, 2018. Further, in lieu of applying the Final Regulations, a taxpayer may rely on the 2018 Proposed Regulations in their entirety for taxable years ending before the Final Regulations were published in the Federal Register. The 2019 Proposed Regulations are proposed to apply to taxable years beginning on or after the date such regulations are finalized, but taxpayers can rely on the 2019 Proposed Regulations currently.
1. For these purposes, the constructive stock ownership rules of section 318 apply, except that the threshold for constructive ownership of corporate-owned stock is 10% (rather than 50%) of value.
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