Posted by Fletcher Accounting and Tax Service Inc.

Base Erosion and Anti-abuse Tax: What does it entail?

Base Erosion and Anti-abuse Tax: What does it entail?

Final regulations were issued by the Treasury and the Internal Revenue Service (IRS) to implement the base erosion and anti-abuse tax or BEAT. A series of important proposed regulations were also issued.

The administrative burdens of Prop. Treas. Reg. § 1.59A-2(e)(3)(vii) was discussed by many commenters with regards to affiliated groups in which there are different company year ends. As a result, a ‘with-or-within year-end’ method has been adopted under the final regulations to find out the gross receipts and the percentage of the base erosion of an aggregate group. There were comments that requested the final regulations to provide an exception from the term ‘base erosion payment.’ This is for revenue sharing payments or arrangements such as allocations in terms of global dealing operations. Some comments specifically recommended that the final regulations must state payments as not a base erosion payment in situations where a domestic corporation makes payments to parities that are foreign-related. In situations like these which can be all too common, Treasury and the IRS declined to make changes.

However, amounts transferred to or exchange with a foreign-related party in a transaction described in §§ 332, 351, and 368 (corporate nonrecognition transaction) from the base erosion payment definition is generally excluded by the final regulations. This approach in the proposed regulations by Treasury and the IRS was criticized and would have transformed a lot of routine tax-free transactions into concerns on base erosion. However, these transactions can still be applied by BEAT to the extent they are taxable. For instance, when ‘boot’ is received.

However, a new anti-abuse rule was also implemented to address these transactions. 

It’s Treas. Reg. § 1.59A-9(b)(4). The anti-abuse rule states that a transaction with the main purpose of leveling up the basis in property acquired in a transaction that is non-recognition will not qualify as an exception for the non-recognition transaction. It will be deemed to have the tainted principal purpose if the basis step-up transaction is within six months prior to the non-recognition transaction.

The important services cost method (SCM) exception is retained by the final regulations, and the proposed regulations are unchanged.

A regulatory exception to the definition of a base erosion payment for a payment that may result in subpart F, global intangible low-taxed income (GILTI), or passive foreign investment company (PFIC) inclusions is not provided by the final regulations. Therefore, if for instance, the payment to a controlled foreign corporation (CFC) results to GILTI, a base erosion payment can still be observed.

General anti-abuse rules were also included in the BEAT regulations. The ‘principal purpose’ standard is clarified by the final regulations by adding new examples that show the differences between transactions that are found to be abusive or non-abusive by the Treasury and the IRS.

An election is provided by the new proposed regulations wherein a taxpayer may forego a deduction for all U.S federal tax purposes permanently, with the result the deduction that was foregone will be considered as a base erosion tax benefit. To avoid the ‘cliff’ effect of the BEAT rules, this could be very helpful. The election can be done when the return is filed or during or due to, a later examination by the IRS.  Since a taxpayer could elect to forego deductions on audit, this is very helpful especially if the effect of adjusting the audit is to send the taxpayer over the BEAT ‘cliff.’

For a better understanding on how BEAT works, let’s have a look at this example:

In 2019, the gross income of a US corporation is $300 million. However, it is making deductible royalties payments amounting to $200 million to a foreign affiliate. The regular tax liability of the corporation is $21 million but $30 million in its alternative tax. This means the corporation would pay $30 million to the United States which $21 million regular tax plus the BEAT of $9 million.

Simply put, the BEAT as stated under the Tax Cuts and Jobs Act limits multinational corporation’s ability to shift profits from the U.S by making deductible payments to their affiliates in countries with low-taxes.

Fletcher Accounting and Tax Service Inc.
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