By Anthony Diosdi
Introduction to the BEAT Tax Regime
The 2017 Act introduced the Base Erosion Anti-Abuse tax (“BEAT”) as codified
under Internal Revenue Code Section 59A, which is designed to prevent base
erosion in the crossborder context by imposing a type of alternative minimum
tax, which is applied by adding back to taxable income certain deductible
payments, such as interest and royalties, made to related foreign persons. As a
threshold matter, the BEAT provisions generally do not apply to small to
medium-sized “C” corporation structures but will apply to applicable “C”
corporation groups that have average annual gross receipts for a three-taxable
year look back period period ending with the preceding year of at least $500
million. (BEAT does not apply to Regulated Investment Companies (“RIC”)
and Real Estate Investment Trusts (“REIT”). In other words, BEAT applies to
corporations (other than RICs, REITs, or S corporations) with gross receipts of
at least $500 million over a three-year testing period and a “base erosion
percentage” ( as defined in Section 59A(c)(4)(A)) for the taxable year of at
least 3 percent. A 2 percent threshold applies for banks and registered
securities dealers. The BEAT applies to U.S. branches with effectively
connected gross receipts of $500 million or more.
The base erosion minimum test is the excess of 10 percent of the taxpayer’s
modified taxable income (as defined in Section 59A(c)) over the taxpayer’s
regular tax liability (reduced to 5 percent for tax years beginning in 2018
with an increase to 12.5 percent for taxable years after 2025).
The Type of Inbound Transactions Involving Foreign Corporate Parents that
will be Impacted by the New BEAT Tax Regime
The BEAT regime will significantly impact a number of cross-border industries
involving the flow of cross border funds from parent corporations to
affiliates. BEAT can be thought of as protecting the U.S. federal income tax
base from “inappropriate” income stripping by imposing a partial clawback of
deductions associated with payments to so-called related parties. What BEAT
does is impose an additional tax of 5 percent on these transactions for the
2018 tax year (the tax increases to 10 percent for the 2019 through 2025 tax
years and increases to 12.5 percent for tax years thereafter). A “related
party” for BEAT purposes is set forth in Internal Revenue Code Section 482.
Internal Revenue Code Section 482 states that:
In any case of two or more organizations, trades or business *** owned or controlled directly or indirectly by the same interests, the [IRS] may distribute, apportion, or allocate gross income, deductions, credits, or allowances, between or among [them], if [it] determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any [of them].
The provision applies whether or not the taxpayers are
incorporated, whether they are domestic or foreign and whether or not they are
“members of an affiliated group.” See Treas. Reg. Section 1.482-1(i)(1).
The regulations explain that the purpose of the provision is to place “a
controlled taxpayer [i.e., a member of a commonly controlled group] on a tax
parity with an uncontrolled taxpayer by determining the true taxable income
of the controlled taxpayer. See Treas. Reg. Section 1.482-1(a)(1)
(emphasis added). The appropriate standard is usually characterized as fair
market value or “arm’s length” pricing. See Treas. Reg. Section
1.482-1(b)(1). In general, this standard is met if the results of the
transaction are consistent with results that would be obtained if the parties
were not related. As in other instances in which the value of noncash assets or
of services must be determined, the difficulty of applying this standard will
depend on the nature of the transaction being analyzed.
The definitional reach of Internal Revenue Code Section 482 is broad, covering
virtually any conceivable business arrangement between or among any commonly
controlled individuals, businesses, or types of entities. The potential reach
of the provision is extended further by the broad definition of “control” that
is applied. The regulations provide that control means “any kind of control,
direct or indirect, whether legally enforceable, and however exercisable or
exercised.” The regulations assert further that the “reality,” rather than the
“form,” of the control will be “decisive” and that “[a] presumption of control
arises if income or deductions have been arbitrarily shifted.” Control might
also be found where two or more unrelated taxpayers act in concern or with a
common goal or purpose. See Treas. Reg. Section 1.482-1(i)(4). The
control test can be applied on the basis of relationships extant at the time
transactions are planned.
With the considerations discussed above, in any case involving an inbound structure involving a foreign parent corporation with a U.S. subsidiary the following must be considered: 1) whether the corporations at issue are the type of corporations to which the BEAT tax regime will apply; 2) whether and to what extent “base erosion payments” as defined by Internal Revenue Code Sections 59A and 482 are made to foreign-related parties; 3) whether the $500 million threshold is satisfied; and 4) calculating the “base erosion percentage” discussed above.
The BEAT regime will require the restructuring of a number of inbound operations
which trigger the $500 million threshold and the “base erosion percentage”
threshold of three percent. For example, consider a foreign parent corporation
located in Europe which owns a U.S. subsidiary as well as subsidiaries based
throughout Asia. For purposes of this example, assume that an unrelated
business bills invoices to the European parent corporation. The European parent
corporation in turn issues invoices as appropriate to its U.S. subsidiary and
its non-U.S. Asian subsidiary groups. Assuming the corporations in the example
satisfy the BEAT threshold, the transaction in the example above can trigger a
BEAT liability because it involves a controlled group (European parent
corporation, U.S. subsidiary, and Asian subsidiary groups) and the likely
deduction of paid invoices. The invoicing of business bills to the corporate
group involves the sharing of expenses. The regulations under Section 482
recognize cost sharing agreements. As a matter of fact, the Conference
Committee Report to the 1986 Act states that, while Congress intends to permit
cost sharing arrangements, it expects them to produce results consist with the
purpose of the commensurate-with-income standards in Section 482- i.e., that
the “income [or deductions] allocated among the parties reasonably reflect the
actual economic activity undertaken by each.” See H.R. Conf. Rep. No.
841, 99th Cong., 2d Sess. II-638 (1986).
To avoid potential BEAT taxable payments, the relationship would need to be restructured whereby each corporate entity is claiming a deduction which is consistent with the actual economic activity undertaken by each. This would avoid the related foreign persons rule for purposes of adding back taxable income to deductible payments.
In another example, let’s assume a foreign parent corporation owns
a U.S. subsidiary that acts as the headquarters for other U.S. subsidiaries as
well as non-U.S. subsidiaries based on South America. Let’s further assume that
the European foreign parent corporation has delegated to its U.S. subsidiary
the ability to not only oversee its U.S. operations but also its South American
operations. Finally, let’s assume that an unrelated vendor issues invoices to
the foreign parent corporation. The foreign parent corporation in turn issues a
sub-billing to its U.S. subsidiary, which in turn issues invoices to its
consolidated group in the United States and South America. In this case, all
the parties are related parties as defined in Section 482 and thus could be
subject to the BEAT clawback provisions. To avoid potential BEAT tax problems,
the relationship between the parties would need to be restructured whereby the
unrelated vendor invoices the foreign parent corporation for non-U.S.-related
activities and the U.S. subsidiaries for U.S.-related activities.
New Compliance Burdens Imposed by BEAT
The BEAT provisions will also impact information reporting on the IRS Form 5471. BEAT transactions will need to be reported on a new Schedule G of the Form 5471. BEAT also impacts the preparation of IRS Form 5472. This year, the IRS has added a new Part VII to Form 5472 dealing with base erosion payments. The IRS also increased the penalty for failure to properly complete a Form 5472 and furnish information from $10,000 to $25,000.
Anthony Diosdi concentrates his
practice on tax controversies and tax planning. Diosdi Ching & Liu, LLP
represents clients in federal tax disputes and provides tax advice throughout
the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email:
Anthony Diosdi – adiosdi@sftaxcounsel.com
This article is not legal or tax advice. If you are in need of legal or tax
advice, you should immediately consult a licensed attorney.