Posted by Elliot Kravitz, ATP

The basics of base erosion and anti-abuse tax. How does it work?

The basics of base erosion and anti-abuse tax. How does it work?

What is the TCJA charge against base erosion and anti-abuse tax, and how does it work?

Base-Erosion and Anti-Abuse Tax (BEAT), a new tax under the Tax Cuts and Job Acts (TCJA), limits the ability of multinational corporations to transfer profits from the United States, by making deductible payments to their subsidiaries in low-tax countries.

Note:

  • BEAT was introduced into the tax law and the reduction of the workforce. In essence, it works as an alternative minimum tax (AMT), which was removed by the reform law.
  • Average annual gross revenue of at least $ 500 million over the past three years.
  • A basic erosion rate of at least 3% (2% for members of the financial group).

Over the past few decades, U.S. multinational corporations have used a variety of techniques to transfer profits from the U.S. to other countries (and thereby erode the U.S. tax base). An American multinational could, for example, pay a branch in a country where taxes are lower to use U.S. patents or other intellectual property. This would increase the costs of the American company, thereby reducing the income declared in the United States and increasing the profits and bringing lower tax revenues in the country, which could reduce the overall tax account of the company. Old U.S. tax laws tried to limit the change in benefits, primarily by regulating the so-called transfer pricing between companies, but the IRS has worked to enforce these laws effectively.

To limit future income changes, the Tax Cuts and Job Acts (TCJA) have added a new tax, BEAT (Base Erosion and Abuse Tax). BEAT is for large U.S. companies that make deductible payments, such as interest, royalties, and certain fees for services, to third parties. 

BEAT is a minimum tax supplement: an American company calculates its regular U.S. tax, with a rate of 21%, then recalculates the tax at a lower BEAT rate after adding the deductible payments again. If the normal tax is lower than the BEAT, the company must pay the normal tax plus the excess of the BEAT over the normal tax. The BEAT rate is 5% in 2018, 10% in 2019 by 2025, and 12.5% in 2026 and beyond.

For example, let's say that in 2020, an American company has a gross revenue of $ 300 million, but pays deductible royalties to a foreign branch of $ 200 million. The company's regular tax debt is $ 21 million (21% of $ 100 million), but its alternative tax is $ 30 million (10% of $ 300 million); therefore, the company would pay $ 30 million in the United States ($ 21 million normal tax plus $ 9 million).

BEAT only applies to large multinational companies, with gross revenues of more than $ 500 million (in the past three years, on average). It also only applies to a company that makes more than 3% of the total deductible payments at foreign branches. 

However, BEAT excludes payments, which can be considered as the cost of products sold. For example, if an American company correctly accounts for royalties or interest as part of the cost of inventory, interest or royalties are not added to the BEAT tax base.

Elliot Kravitz, ATP
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