US tax officials highlight key provisions in new BEAT regulations 

by Julie Martin, MNE tax

US IRS and Treasury officials on December 14 discussed the just-released proposed base erosion anti-abuse tax (BEAT) regulations at a Washington DC tax conference, explaining the reasoning behind many positions taken by the government in the regulations.

Speaking at the 31st Annual Institute on Current Issues in International Taxation, co-sponsored by the IRS and George Washington University Law School, D. Peter Merkel, Acting Branch Chief, (ACCI), said that a literal reading of the statutory language of the BEAT would result in many payments that Congress intended to be base erosion payments to fall outside the statute.

To make the statute work as intended, the government decided that, for purposes of defining applicable taxpayers, the regs should provide that the aggregate group is limited to domestic corporations plus all foreign related parties that are subject to US net basis tax, Merkel said.

Kevin Nichols, Senior Counsel, (ITC) at the US Department of Treasury explained that under the regs’ approach, an aggregate group is “a somewhat a fluid concept” which depends on whether a payment to a foreign payee is subject to US net income tax or not.

“So, with respect to any particular foreign payee . . . you may be in the group with respect to one payment and out of the group with respect to another type of payment,” Nichols said.

ECI exception

Nichols said that consistent with this new aggregate group concept, the regs add an exception to the definition of a base erosion payment for amounts paid or accrued to a foreign related party that are treated as effectively connected income (ECI).

“When we define the aggregate group, we sort of draw a box around all the US corporations as well as the foreign entities to the extent they are subject to net US taxation. So, those transactions are all disregarded for purposes of determining the base erosion percentage and determining if you are an applicable taxpayer. And, once you are an applicable taxpayer, then that same payment would technically meet the definition of a base erosion payment. In order to create symmetry between the aggregate group concept and what a base erosion payment is we linked those two so that there is this exception . . . which says that payments subject to net taxation are an exception from the base erosion payment definition,” he said.

Rocco Femia, Miller & Chevalier, commented that the government’s decision to add the ECI exception is “very reasonable.” It is hard to think of a payment as a base erosion payment when it is picked up by the recipient and taxed in the US, he said. Femia asked why a similar rule was not provided for payments to foreign related persons that are Subpart F income or for GILTI income.

Nichols responded that the BEAT’s ECI exception stems from the need to define the aggregate group concept so that the statute would not apply to just a few taxpayers; no such consideration applies for Subpart F or GILTI inclusions.

He also said that for ECI, the same taxpayer is involved whereas for Subpart F and GILTI, the same taxpayer is not involved, instead the income is included by the US shareholder. Because of this, extremely complex tracing rules would be needed, he said.

Non-cash payments, reorganizations, cost sharing

Nichols also said that the regs make it clear that base erosion payments do not need to be made in cash and can occur in the context of a tax-favored transaction.

There is no logical basis to exclude non-cash consideration, including payments of stock, from the defintion of base erosion payments or to exclude a situation where the delivery of the noncash consideration is in connection with a transaction that has special status under the code, such as a reorganization or a section 351 transaction, he said.

Joshua Odintz of Baker McKenzie commented that this rule, coupled with the GILTI regulations, will make it more difficult for taxpayers to move intellectual property from lower tax structures to the US or to other jurisdictions.

Nichols said that base eroding payments from US participants to a foreign related party can also be made in the context of a cost-sharing arrangement.

Some commentators looked to section 1.482 -(7)(j)(3) as deeming such payments as being made to third parties and thus not a base erosion payment, Nichols said. “We don’t think that’s the result you get under existing law . . . it’s not changing the cost-sharing as running from the participant to the third party,” he said.

Services cost method mark-up exception

Nichols said that the proposed regs take the position that if you meet all the requirements of the services cost method exclusion from the definition of base erosion payments, the exclusion is available to the extent of the cost but not the to extent of any markup.

While it has been clear the exclusion would apply to US corporations that reimburse a foreign related taxpayer for costs of services provided by the foreign party, there had been controversy regarding whether and how the exclusion would apply if a markup is added to the payment, Nichols noted.

During a separate panel, Julia M. Tonkonvich, Principal, International Tax Services at Ernst & Young, LLP, Washington, said that the regs’ clarification is welcome as companies have wondered if they need to forgo the markup component to take advantage of services cost method exception and, if they did forgo the markup, how the foreign jurisdiction would react.

Tonkonvich said that the regs’ disaggregation approach is a reasonable interpretation of the statute.

COGS exception

Tonkonvich also said that companies have been spending significant resources trying to determine what costs can be properly capitalized and thus considered reductions to gross receipts for purposes of cost of goods sold (COGS) rather than as deductible payments subject to BEAT.

Companies that realize they have been deducting items that should have been included in COGS now want to apply for a change in accounting method but are concerned that the government may disregard a method change even if it is from an improper method, Tonkonvich said.

According to Daniel Winnick, Attorney-Adviser, (ITC), US Department of Treasury, though, this fear is unfounded. Unlike the Section 965 transition tax, the BEAT provisions do not include a special anti-abuse rule aimed at changes in accounting methods, Winnick observed. He said that taxpayers should look to the normal rules for accounting method changes for guidance.

Banks, securities dealers, Section 989 losses

Merkel also said that the regs add taxpayer-favorable de minimis rules providing that if a small percentage of a group’s activities include banking and securities dealer activities the lower, 2 percent base erosion threshold applicable to banks will not apply.

Instead, the general 3 percent threshold applies making it less likely that the group will be subject to BEAT. The de minimus rule applies when the group’s gross receipts from banking or securities dealer activities are 2 percent or less of total reciepts.

The regs clarify that that term “securities dealers” does not include brokers, as some taxpayers had feared, Merkel said. He said the government decided to define the term by looking to securities law.

Nichols said that the government, after a lot of thought, decided to apply a neutral rule for section 988 losses, noting that such payments can be very common. These losses are not treated as base erosion payments and are also excluded from the denominator when computing the base erosion percentage, he said.