The final and proposed BEAT regulations: what changed, what’s new, and what’s next?

By Amanda Varma, Partner, Steptoe & Johnson, Washington DC

On December 2, the US Treasury and IRS released final regulations on the base erosion anti-abuse tax (BEAT) under section 59A of the Internal Revenue Code.  Treasury and the IRS also issued proposed regulations under the BEAT.

The BEAT was enacted as part of the 2017 US tax reform.  It applies to certain large corporate taxpayers that have more than a de minimis amount (generally 3%) of certain tax benefits from payments to foreign related persons compared to all of such tax benefits.

The BEAT effectively operates as a minimum tax on a modified tax base that adds back to taxable income tax benefits from deductible and certain other payments to related foreign persons. The tax rate is generally 5% in 2018, 10% in 2019, and 12.5% in 2026.

Final regulations

The final regulations are consistent with the general approach of the proposed regulations released in 2018, with some modifications that are generally taxpayer-favorable.

However, the regulations do not go as far to narrow the potential application of the statute as some taxpayers had hoped. 

In particular, the regulations do not contain an exception for payments included in the income of a US person under the subpart F, global intangible low-taxed income (GILTI), or passive foreign investment company (PFIC) rules, a general rule that permits netting of payments, or an exception for revenue sharing arrangements. 

 With respect to taxpayer-favorable changes, the final regulations contain an important exception for amounts connected to certain nonrecognition transactions. Under the statute, the modified BEAT tax base looks to tax benefits from “base erosion payments,” a term that includes “any amount paid or accrued by the taxpayer to a related foreign person for the acquisition of depreciable or amortizable property.”

The proposed regulations would have treated the provision of non-cash consideration, such as stock, as an amount potentially “pair or accrued” for this purpose. Thus, the transfer of stock in certain nonrecognition transactions could give rise to a base erosion payment.

The final regulations generally exclude from the base erosion payment definition amounts transferred to, or exchanged with, a foreign related party pursuant to a nonrecognition transaction under sections 332 (liquidations), 351 (transfers to a controlled corporation), 355 (distributions of stock of a controlled corporation), or 368 (reorganizations). The exception does not apply, however, to amounts treated as “other property.”

The final regulations contain a favorable change for fiscal year taxpayers with respect to the applicable BEAT rate. For taxpayers with fiscal years beginning in calendar year 2018, there was a question regarding whether the 5% rate should apply for the entire calendar year or whether a blended rate should apply. The proposed regulations provided for a blended rate for taxable years beginning in 2018, while the final regulations do not.

The final regulations also make other changes, including clarifying and expanding the anti-abuse rules, providing that a built-in loss amount triggered is not itself a base erosion payment, expanding special rules for certain global systemically important banking organizations, clarifying the application of the rules to partnerships, providing an exception for certain reinsurance claims payments, and changing the treatment of foreign currency losses.

The final regulations retain the same general approach as the proposed regulations with respect to the “add back” method of calculating modified taxable income as well as the “services cost method” exception.

Proposed regulations

Both the applicability of the BEAT and the calculation of the modified tax base (specifically, the definition of “base erosion tax benefit”) take into account deductions “allowed” for the taxable year. The newly released proposed regulations would permit a taxpayer to elect to permanently forgo a deduction for all US federal income tax purposes so that the forgone deduction is not treated as a base erosion tax benefit.

This is election is likely to be most beneficial to taxpayers that are slightly over the 3% (or other applicable) threshold used to determine BEAT applicability. Until the proposed regulations are finalized, a taxpayer choosing to rely on the proposed regulations may attach a statement to its Form 8991 (Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts) containing the information listed in the proposed regulations.

In addition, the proposed regulations address the gross receipts test used to determine whether the BEAT applies to a taxpayer, the treatment of members leaving and joining groups, and issues with respect to the application of the BEAT to partnerships.

What’s next

The election to waive deductions in the proposed regulations will come as welcome news to some taxpayers close to the threshold for BEAT applicability.

In addition, because the election is proposed to be available on an amended return or during the course of an examination of a taxpayer’s return, some taxpayers facing a potential BEAT dispute with the IRS may choose to incur the cost of waived deductions in exchange for increased certainty. 

Some taxpayers with business models involving revenue sharing, offsetting payments, or passthrough payments with foreign affiliates will be disappointed that the regulations do not provide relief in situations that arguably do not present a significant base erosion concern.

However, the text of the final regulations does explicitly acknowledge that, the determination of the amount paid or accrued, and the identity of the payor and recipient of any amount paid or accrued, is made under general US federal income tax law. A similar statement was included in the preamble of the proposed regulations, but not the regulatory text.

Taxpayers should consider the potential applicability of principles of generally applicable tax law, including agency principles, reimbursement doctrine, conduit principles, and assignment of income, in determining whether base erosion payments arise.