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We Got the BEAT: the IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax Regulations by Mark Leeds & Lucas Giardelli1

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We Got the BEAT: the IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax Regulations by Mark Leeds & Lucas Giardelli1 December 11, 2019 We Got the BEAT: The IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax Regulations By Mark Leeds & Lucas Giardelli1 The Go-Go’s were a unique early 1980s pop I. Background band because it was comprised solely of women who wrote, as well as performed, their The BEAT functions as a minimum tax in that it own music. Their style was groundbreaking only applies if a taxpayer’s liability under the and defined what came to be known as the BEAT (referred to as “base erosion minimum “new wave.” And the songs were very catchy. tax amount” or “BEMTA”) exceeds its regular When the base erosion and anti-abuse tax tax liability.4 The BEAT is applicable only to (commonly known as the “BEAT”) was added taxpayers with 3-year average annual gross to Section 59A of the Internal Revenue Code receipts of at least $500 million and then only of 1986, as amended (the “Code”) at the end if their “base erosion percentage” exceeds a of 2017, it too heralded a new wave . of specified threshold (3% for taxpayer groups taxation. Just like we’re always looking to hear without domestic banks and securities dealers what’s next from our favorite musicians, the and 2% for groups with domestic banks tax bar has been feverishly anticipating more and/or securities dealers that generate more BEAT guidance. Luckily for us, on December 2, than a de minimis amount of income).5 2019, the US Internal Revenue Service (the Although the BEAT potentially applies to all “IRS”) issued final regulations interpreting the large taxpayers, it is likely to have significant BEAT rules2 (the “Final Regulations”) and application to banks and insurance promulgated new proposed regulations (the companies. “2019 Proposed Regulations”) offering The BEAT adds back most payments made by additional opportunities for affected taxpayers US taxpayers and US branches of non-US to address BEAT issues. taxpayers to their non-US affiliates (that is, The Final Regulations apply to 2019 tax years. non-US persons connected through 25% or For 2018 tax years, taxpayers may elect to greater common ownership) to taxable apply the Final Regulations or the 2018 income to arrive at “modified taxable Proposed Regulations, so long as either set of income.”6 The BEAT is then applied to this regulations is applied in its entirety. Taxpayers modified taxable income and, if this tax may also rely on the 2019 Proposed exceeds the taxpayer’s regular tax, the excess Regulations for 2018 and subsequent tax or BEMTA is owed as an additional tax. years so long as such rules are also applied in The first step in determining whether the BEAT 3 their entirety. applies to a particular taxpayer is to ascertain whether the taxpayer is an “applicable taxpayer.”7 A taxpayer will be treated as an applicable taxpayer if it meets three tests: 1. The taxpayer must be a corporation, but goods sold. Base erosion payments do not not a regulated investment company, a include “qualified derivative payments” within real estate investment trust or an S the meaning of Code § 59A(h) or payments corporation; made by a US taxpayer for services that may 2. The taxpayer must have aggregate be accounted for on the “services cost average gross receipts for the preceding method” under Code § 482 to the extent such three years of at least $500 million; and amount constitutes the total services cost without mark-up.10 3. The taxpayer’s base erosion percentage for the taxable year must be 3% or higher The BEAT rate varies by year and by whether (2% in the case of US banks and registered the taxpayer is a US bank or a registered securities dealers).8 securities dealer. Specifically, the BEAT rate is Special, and fairly complex, rules apply to 10% in 2019 through 2025 and 12.5% 11 determine whether the second and third tests thereafter. These rates are increased by one are satisfied, including calculations on an percentage point for US banks and registered 12 “aggregate group” basis. securities dealers. If a taxpayer meets the definition of an applicable taxpayer, the application of the II. Threshold Issue – The BEAT provisions begins with the determination Determination of Gross Receipts of “modified taxable income.” Modified As noted above, only taxpayers with average taxable income is taxable income determined annual gross receipts of at least $500 million without regard to any “base erosion tax (measured on an “aggregate group” basis) are benefit” with respect to any “base erosion subject to the BEAT.13 Following the 2018 payment.”9 A base erosion payment includes Proposed Regulations, the Final Regulations any amount paid or accrued by the taxpayer generally define “gross receipts” by reference to a related foreign person and with respect to to Code §448(c)(3) and the regulations which a deduction is allowable. In general, a thereunder.14 Thus, gross receipts include total foreign person will be treated as a related sales (net of returns and allowances), all party if there is a 25% or greater ownership amounts received for services and income overlap with the taxpayer. A base erosion tax from investments. Gross receipts are not benefit includes a deduction that is allowed reduced by cost of goods sold and do not with respect to a base erosion payment. include repayment of a loan (notably, Base erosion tax benefits generally include however, gross receipts would generally deductible payments for services, interest, include the gross proceeds from the sale of a rents and royalties. Depreciation and loan by a bank). amortization deductions with respect to property acquired from related foreign III. Aggregate Group Calculations persons may also be considered base erosion tax benefits and be disregarded in Code § 59A determines the status of a determining modified taxable income. No corporation as an “applicable taxpayer” by amount is generally added back in measuring gross receipts and the base erosion determining modified taxable income for percentage by reference to the corporation’s payments to foreign related persons that are “aggregate group.” A question arises as to not deductible, but instead reduce gross how these items should be measured when income, e.g., amounts included in cost of members of the aggregate group have different taxable years than the tested 2 Mayer Brown | We Got the BEAT: The IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax Regulations taxpayer. The 2018 Proposed Regulations the period they were members shall be taken provided that each taxpayer determines its into account.19 gross receipts and base erosion percentage by reference to its own taxable year, taking into IV. Mark-to-Market Transactions account the results of other members of the aggregate group during such taxable year As discussed above, a taxpayer will be subject (regardless of such other members’ own to the BEAT only if its base erosion percentage respective taxable years). This approach raised exceeds 3% (2% for aggregate groups that administrability concerns because many include domestic banks or broker dealers). The companies do not maintain detailed monthly fraction compares base erosion tax benefits accounting records. Heeding this concern, the (the numerator) with the aggregate amount of 20 Final Regulations change to a “with-or-within deductions (the denominator). Deductions method”: the gross receipts and base erosion for mark-to-market losses increase the percentage are calculated on the basis of the denominator of the fraction and are therefore tested taxpayer’s taxable year and the taxable helpful to taxpayers in avoiding breaching this year of each member of its aggregate group threshold. The Final Regulations retain an that ends with or within the tested taxpayer’s unfavorable rule, however, for determining taxable year.15 mark-to-market losses. Although under general mark-to-market accounting, income The Final Regulations clarify that a transaction earned on a position is not taken into account between members of the same aggregate in determining the mark-to-market group is disregarded when determining the adjustment,21 such items are netted against gross receipts and base erosion percentage, the amount of loss that may be added to the so long as both parties were members of the denominator of the base erosion same aggregate group at the time of the percentage.22 Accordingly, if a taxpayer transaction. It is irrelevant whether the parties receives a $10x interest payment on a debt were members of the same group on the last instrument and has a $100x mark-to-market 16 day of the taxpayer’s taxable year. In loss with respect to such debt instrument at addition, for purposes of calculating the base the end of the year in which the payment is erosion percentage, the Final Regulations received, only $90x of losses are added to the exclude deductions attributable to a taxable denominator of the base erosion percentage. year of a member that began before January 17 1, 2018. V. Base Erosion Payments Treasury also addressed certain mechanical There are generally three types of payments aspects of the aggregate group calculations in that when made by a US taxpayer (including a the 2019 Proposed Regulations. Recognizing US branch of a non-US corporation) to a that the existing rules may lead to over- or foreign related party are treated as base under-counting in the case of taxpayers with erosion payments: (i) deductible payments, (ii) short taxable years, the 2019 Proposed a payment for the acquisition of depreciable Regulations would require such taxpayers to or amortizable property, (iii) reinsurance use a “reasonable approach” in determining premiums.23 The Final Regulations clarify that the base erosion percentage and gross other reductions to gross income (including receipts of their aggregate group.18 The 2019 cost of goods sold) are not base erosion Proposed Regulations would also provide that, payments.24 The question as to whether a in the case of members that join or leave the aggregate group, only items accrued during 3 Mayer Brown | We Got the BEAT: The IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax Regulations payment or accrual is deductible is made in loss property.
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