A year after the initial proposed BEAT regulations were released, Treasury and the IRS have issued a package of final and proposed regulations under § 59A of the Internal Revenue Code of 1986, as amended (the Code), the contents of which are generally consistent with early rumors. The final regulations follow closely the proposed regulations, offering limited relief on key questions under the proposed regulations, including providing that:
- Acquisition of assets in a corporate non-recognition transaction is not a base erosion payment, subject to certain limited exceptions;
- Losses on the transfer of loss property to a related party are not considered to be base erosion payments; and
- Fiscal year taxpayers are entitled to a 5 percent BEAT rate for their first fiscal year, and § 15 does not apply.
In addition, proposed regulations released at the same time confirm pre-release rumors and give taxpayers the option to disallow part or all of any related-party deductions, in order to remain below the base erosion percentage thresholds. This election would blunt the “cliff effect” of the base erosion percentage thresholds in the statute. Significantly, this option can be exercised on an original return, an amended return, or during an audit, but once exercised cannot be revoked. There also are safeguards to ensure that the taxpayer is not able to take the benefit of a disallowed loss in a future year.
In issuing the final regulations, the IRS and Treasury rejected requests to provide exceptions for payments that give rise to income that is taxable under subpart F or the global intangible low-taxed income (GILTI) provisions of § 951A. The preamble indicates that such exceptions are not in keeping with the policy underlying the provision and, particularly in the case of GILTI, would be difficult to administer. The IRS and Treasury also rejected requests for netting of payments, including netting provisions under reinsurance contracts. The final regulations key off of general federal income tax principles for purposes of determining whether a payment is a deductible payment and, therefore, a base erosion payment.
The Final Regulations
Assets Acquired in Corporate Non-Recognition Transactions
The final regulations reverse a widely criticized rule from the proposed regulations regarding the treatment of amortization from assets acquired by a taxpayer from a related foreign person in a non-recognition transaction. The proposed regulations would have treated such a non-recognition transaction as a base erosion payment, and correspondingly, the related amortization as a base erosion tax benefit. The final regulations generally reverse course from the proposed regulations, providing that a corporate non-recognition transaction is not a base erosion payment, except to the extent of boot. The amount of any boot is allocated pro rata across all assets acquired in the non-recognition transaction, and amortization related thereto is treated as a base erosion tax benefit. From a policy perspective, the preamble to the final regulations notes that this exception is consistent with the general desire to eliminate disincentives for taxpayers that otherwise hold assets offshore to repatriate those assets.
An anti-abuse rule is included in the final regulations to prevent taxpayers from engaging in transactions that are designed to step up the basis in assets before their transfer to a taxpayer in a corporate non-recognition transaction. These rules apply if a transaction or series of transactions has a principal purposes of increasing the adjusted basis of property that a taxpayer acquires in a corporate non-recognition transaction, and presume such a purpose if there was a sale of the assets between related foreign persons within 6 months of the corporate non-recognition transaction. It will be important for US taxpayers to consider the application of the anti-abuse rules, particularly in the case of post-acquisition restructuring transactions following the acquisition of a foreign corporation.
The exception for amortization of assets acquired in corporate non-recognition transactions is limited to corporate transactions and does not apply in the partnership context. As the preamble explains, this is because the aggregate theory of partnerships applies in determining BEAT liability. Under the aggregate theory, a partner contributing property to a partnership is treated as having transferred a portion of the interest in such property to its partners for purposes of BEAT, which is not a non-recognition transaction.
The final regulations also reverse course from the proposed regulations in the treatment of transfers of built-in loss property to a related foreign person. Under the proposed regulations, a loss incurred on a transfer of property to a related foreign person would have been treated as a base erosion payment. Responding to comments, the final regulations recognize that such a loss is not attributable to the transaction with the related foreign person; rather it arises from the investment in the transferred asset. Accordingly, such losses are not treated as base erosion payments under the final regulations.
Initial Year BEAT Rate for Fiscal Year Taxpayers
In another departure from the proposed regulations, the final regulations provide that the BEAT rate of 5 percent will apply to a fiscal year taxpayer for its full taxable year beginning in 2018. Under the statutory language, the BEAT rate is “equal to 10 percent (5 percent in the case of taxable years beginning in calendar year 2018)” and then 12.5 percent for any taxable year beginning after December 31, 2025. Section 15 of the Code generally provides that where there is an increase in the tax rate during the year, the rate is pro-rated. The proposed regulations concluded that § 15 applied, meaning that fiscal year taxpayers would not get a full year’s benefit at the 5 percent initial rate.
The final regulations apply the first-year BEAT rate of 5 percent to a taxpayer’s first fiscal year subject to the BEAT, even if the fiscal year includes part of 2019. Section 15 will apply, however, when the BEAT tax rate increases in 2026.
Application of General US Federal Tax Principles
The preamble to the proposed regulations provided that the determination of whether a payment gives rise to a base erosion tax benefit is determined under general US federal income tax principles. There is not a separate determination for purposes of § 59A. Comments requested additional clarification and examples as to how federal income tax principles would apply to a number of factual situations.
The final regulations respond to comments by incorporating the language from the preamble to the proposed regulations in the body of the final regulations. The final regulations do not, however, provide additional guidance regarding the application of general US federal tax principles to specific factual situations. Specifically, the IRS and Treasury rejected requests to provide rules regarding the netting of intercompany payments, or the application of look-through principles where a related foreign person may have offsetting obligations to unrelated parties.
Under the final regulations, taxpayers must continue to make a determination under general US tax principles as to whether a payment gives rise to a base erosion tax benefit. In the case of back-to-back payments, this includes consideration of the reimbursement doctrine or agency and conduit principles. It also includes consideration of whether amounts are properly treated as a reduction of gross income (i.e., cost of goods sold) and therefore excluded from characterization as a base erosion payment.
Payments that are not deductible under current law—for instance, under the reimbursement doctrine—would not be considered a payment for BEAT purposes. However, Treasury and the IRS declined to exclude payments that result in GILTI or subpart F inclusions from the definition of a base erosion payment, believing they had no statutory authority to do so.
Other Modifications in the Final Regulations, Transition Rules and Applicability Date
In addition to the changes described above, the final regulations make certain changes that are intended to ease administration of the regulations, including:
- “With and Within” Method for Purposes of Determining Base Erosion Percentage. The final regulations ease the burden on taxpayers that are part of an aggregate group including multiple taxpayers. Each such taxpayer is required to determine its base erosion percentage separately, and the proposed regulations required making this determination on the assumption that the tax year for each member of the aggregate group ends on the same date as for the taxpayer for which the base erosion percentage is being determined. To minimize the need for multiple calculations, the final regulations allow the determination to be made by reference to the income and expenses of aggregate group members for tax years that end with or within the tax year of the member for which the base erosion percentage is being determined. The proposed regulations also include certain proposed rules to address short years of aggregate group members.
- Treatment of § 988 Losses. The final regulations provide that § 988 currency losses related to payments to a related foreign person are excluded from both the numerator and the denominator in determining the base erosion percentage.
- Securities Lending Transactions. Responding to comments, the final regulations include securities lending transactions in the category of transactions that can qualify for the exception for qualified derivatives payments. Specifically, substitute payments regarding securities lending transactions qualify for the exception from treatment as a base erosion payment. Any interest payable to a related foreign person on such a transaction is, however, treated as a base erosion payment.
- Principal Purpose and the Anti-Abuse Rules. The final regulations also add examples to the anti-abuse rules demonstrating the application of the principal purpose standard. The anti-abuse rules generally apply only if a principal purpose of the transaction or transactions was to avoid the application of the rules of § 59A.
The final regulations apply to taxable years ending on or after December 17, 2018. Taxpayers may apply the final regulations for taxable years beginning after December 31, 2017, and ending before December 17, 2018. Taxpayers may likewise apply the previous proposed regulations in their entirety for all taxable years ending on or before December 6, 2019.
The Proposed Regulations
Proposed Allowable Deductions Waiver
Perhaps the most notable provision in the package is the proposed regulation that would permit a taxpayer to make an election to waive part or all of its allowable deductions for all US tax purposes, which results in the foregone deduction not being treated as a base erosion tax benefit. The preamble to the proposed regulations explains that in such a case, the deduction would not be an “allowed” deduction that would otherwise give rise to a base erosion tax benefit.
A taxpayer is potentially subject to the BEAT only if the percentage of its deductible payments to related foreign persons is at least 3 percent of its total deductible payments (2 percent in the case of certain financial institutes and regulated securities dealers). The election to waive allowable deductions—which can be made on an original return, an amended return, or during an audit—gives taxpayers that are otherwise over this threshold the ability to avoid being subject to BEAT. It thus ameliorates the “cliff effect” of the BEAT. Of course, the determination of whether to make such an election will require weighing the tax cost from losing the deduction against the potential BEAT liability. For taxpayers with significant NOLs, waiving allowable deductions may not result in additional current cash tax cost, but the loss of those NOLs to offset future income could have financial statement impacts. For taxpayers with significant foreign operations and related foreign tax credits, waiving deductions in order to fall below the applicable base erosion percentage will often be worthwhile despite the incremental regular tax cost, because foreign tax credits do not reduce BEAT liability.
The election is made annually and is not considered to be a method of accounting. Thus, a taxpayer may waive an amortization deduction in one year, but claim it in the next year. There are, however, certain safeguards to ensure that a deduction that is waived is not taken into account as a benefit in any future year. Taxpayers also are required to report waived deductions. The waiver is treated as occurring before the allocation and apportionment of deductions.
Other Provisions in the Proposed Regulations and Effective Date
The proposed regulations also include provisions to address the treatment of short years in making the determination of a taxpayer’s base erosion percentage. These proposed regulations are tied to the adoption of the “with and within” method as noted above.
In addition, the proposed regulations include certain rules to address the application of § 59A to partnership transactions, including in the case of special allocations of deductions and where payments otherwise might constitute effectively connected income of a related foreign person.
The provisions relating to the election to waive allowable deductions and the treatment of short years apply to taxable years beginning on or after December 6, 2019, while the provisions relating to partnership transactions apply to taxable years ending on or after December 2, 2019. As with the final regulations, taxpayers may apply the proposed regulations for taxable years beginning after December 31, 2017, and before the final regulations are applicable. Taxpayers may rely on the proposed regulations in their entirety before their finalization.