Article written by:
Brad Denzel, CPA
The Tax Cuts and Jobs Act (TCJA) brought with it many changes, including a major one to international tax law. The Base Erosion and Anti-Abuse Tax, commonly referred to as “BEAT”, is a new alternative minimum tax that applies specifically to US and non-US multi-national corporations who make large payments to foreign related parties after December 31, 2017.
Before diving into the complex structure of the new provision, let’s talk about why this was created in order to gain some background knowledge to better understand the code. The “BEAT” provision addresses an ongoing concern by US tax authorities that large multi-national corporations are reducing (i.e. “eroding”) their US tax base through significant cross-border intercompany transactions. The BEAT is a minimum tax set to limit the perceived benefits of such base erosion payments to foreign related parties typically deductible in the US. The new provision applies a 10% minimum tax rate to a company’s modified taxable income to ensure that corporations are not abusing their foreign party relations (hence the name Base Erosion and Anti-Abuse Tax). However, in addition to capturing these potentially “abusive” structures, the BEAT may also impact certain commonly used business structures used by US and non-US multi-nationals.
Under Section 59A, companies subject to this new tax are as follows:
- Any foreign or domestic corporation (excluding RICs, REITs, and S Corporations)
- Income effectively connected with a US trade or business
- Meets the “substantial gross receipts” test – average annual consolidated gross receipts effectively connected to the US trade or business for the 3 years preceding must exceed US$500 million
- Base erosion payments equal to or greater than 3% of the corporation’s total deductions for the year
BEAT is calculated as 10% (5% for 2018 as a “phase-in year”, and 12.5% for 2026 and beyond) of a corporation group’s modified taxable income in excess of the regular tax liability, after taking foreign tax credits into account. Generally, modified taxable income is taxable income plus any deductions related to base erosion payments to foreign related parties. A foreign party is considered related if at least 25% of the stock is owned by the taxpayer (by vote or vale) or it satisfies other control tests. The impacted intercompany payments include, but are not limited to, amounts paid or accrued for interest, rents and royalties (regardless of whether or not originally treated as Subpart F income). Depreciation and amortization deductions resulting from property acquired from a foreign related party are also added back. No addbacks are required for dividends or payments to related foreign parties that reduce gross receipts (i.e. payments for cost of goods sold, certain procurement commissions). Special rules apply in cases of net operating losses.
Let’s take a look at what this “BEAT” will look like in practice: For example, in 2019, 10% rate per above, a company fitting the description above has taxable income of $50 million and a regular tax liability of $10 million, decreased to $5 million after other tax credits. Adding back deductions from foreign related party payments results in modified taxable income of $75 million, creating a BEAT of $2.5 million ($7.5 million less regular tax liability post tax credits of $5 million).
Concerns have arisen as to whether the BEAT potentially impacts certain sectors (such as service businesses) more heavily than other sectors. Additional guidance is necessary to address this and many other situations in the computing and applying the BEAT, such as:
- Exclusion of services eligible for application of the services cost method under section 482 regulations (i.e. if a mark-up is applied, would the service cost be excluded and only the mark-up added back under BEAT)?
- Potential double taxation, specifically due to lack of ability to net certain related payments (such as a service hub, where the US pays foreign related parties for services, collects the global expenses centrally, and then US recharges to other foreign related parties).
- Treatment of reimbursements of third party/subcontractor service costs (i.e. US pays a foreign related party for services, which the foreign related party subcontracts to a third party).
- Potential double taxation of foreign sourced income from treaty partners due to treatment of certain tax credits in determining the BEAT.
Corporations will need to review and analyze their payments to related foreign parties to assess whether the BEAT may apply and, if so, should they be restructured to reduce potential addbacks to regular taxable income. Please consult with a GBQ advisor to determine how this new tax provision could affect your business.