On December 13, 2018, the Internal Revenue Service (the “IRS”) and the Treasury Department issued proposed regulations (the “Proposed Regulations”) on the Base Erosion and Anti-Abuse Tax (“BEAT”) under section 59A of the Internal Revenue Code. BEAT is a new minimum tax imposed on large corporations that make deductible payments to foreign related persons, called base erosion payments. BEAT is not imposed on all taxpayers, but rather on large corporations that make deductible payments to foreign related persons exceeding a de minimis threshold.
As Background: BEAT was enacted in 2017 as part of the Tax Cuts and Jobs Act (“TCJA”). U.S. corporate taxpayers will be subject to BEAT if they meet the following two conditions. First, the corporation must have a three-year average of gross receipts greater than $500 million. Second, the U.S. taxpayer’s deductions for intercompany payments for services, interest, certain property / assets and royalties must be greater than three percent of its total allowed deductions. Certain alternative thresholds are named for banks and special entities. Additionally, the BEAT provisions do not apply to regulated investment companies, REITs or S-Corps.
If a U.S. taxpayer meets the two requirements, it will be assessed an additional tax to the extent that otherwise applicable income tax is less than 10 percent of modified taxable income (which is taxable income excluding deductions for base erosion payments). The tax under the BEAT provision is equal to 10 percent of the taxpayer’s “modified taxable income” (5 percent for 2018; 12.5 percent after 2025), less applicable tax credits.
Transfer Pricing Perspective: The Proposed Regulations provide key clarifications from a transfer pricing perspective including:
- The amount of any base erosion payment is generally determined on a gross basis and would not permit the netting of amounts owed between the taxpayer and foreign related party.
- Related party payments that are included in the income of a U.S. trade or business should not be treated as base erosion payments.
- If a taxpayer's payments would have qualified for the "service cost method" exception ("SCM") as described in the transfer pricing regulations, but actual charges were made with a mark-up, only the amount paid in excess of the total cost of services (i.e., the mark-up component) would be a base erosion payment.
- Intercompany transactions are excluded from the computation of the base erosion percentage and gross receipts test.
- Payment or accrual by the taxpayer to a foreign related party may be a base erosion payment, regardless of whether the payment is in cash or non-cash consideration (e.g., property, stock or the assumption of a liability).
BEAT will become a significant burden for many businesses with operations in multiple jurisdictions. The SCM exception is an important concession which may be of great assistance to affected taxpayers.