If you’ve been hearing new terms post-TCJA and are unsure about them all, you’re not alone! Likely you’ve tackled the new provisions most pertinent to your company or client base, and maybe developed selective hearing when perusing tax reform guidance and articles that include terms unlikely to affect you and yours. The Base Erosion & Anti-Abuse Tax (BEAT) is probably on this second list! But I’m here to hopefully give a high-level overview that isn’t too painful to read and gives you a basic understanding as to what it is and how it may or may not come into play for you.
The BEAT rules can be found under IRC §59A, and were enacted as part of the Tax Cuts & Jobs Act targeting high gross receipts taxpayers making tax deductible payments to a foreign parent or related party. The goal in provisions like the BEAT was to help make doing business in the U.S. more attractive, and penalizes large multinational companies making significant outbound payments that lower tax in the U.S. and are a lot of times sent to countries of related parties that have no or low tax.
Specifically, the BEAT requires an “applicable taxpayer” to recalculate taxable income without regard to certain tax deductions for “base erosion payments” made to foreign related parties. “Base erosion payments” are amounts paid or accrued by the taxpayer paid to foreign related parties for items such as: interest, royalties, reinsurance, and certain services. The BEAT is similar in theory to the alternative minimum tax (AMT), in that it adds back certain deductions to arrive at a modified taxable income and has its own tax rate applied, which is then compared to regular tax. The amount of BEAT that is in excess of regular tax is considered the BEAT tax liability. Credits such as the foreign tax credit will offset the regular tax liability in this computation, however, for tax years before 2026, the R&D credit and a few general business credits will not reduce the regular tax liability when comparing to the BEAT liability.
The BEAT applies to taxable years beginning after 12/31/17 with the following tax rates:
· 2018: 5%
· 2019-2025: 10%
· 2026+: 12.5%
*Rates are 1% higher for banks or registered securities dealers.
Taxpayers Subject to the BEAT
Not every taxpayer is subject to the BEAT! So before you go and start figuring your BEAT modified taxable income, first determine if it even applies. An “applicable taxpayer” that will be subject to the BEAT meets each of the following conditions for the taxable year:
1) Taxed as a Corporation, other than an S-Corporation, regulated investment company (RIC), or real estate investment trust (REIT)
2) Has average annual gross receipts for the three year period ending with the preceding taxable year in excess of $500M, and
3) A base erosion percentage of 3 percent or more (or greater than 2% if taxpayer is or has in their affiliated group a bank or registered securities dealer)
For the purposes of the gross receipts test, gross receipts are reduced by returns and allowances made during a taxable year. For insurance companies, gross receipts are reduced by return premiums, but not by any reinsurance premiums paid or accrued. The proposed regulations provide guidance on handling complex situations where aggregated taxpayers do not have the same year end, or have not been in existence for 3 years.
The base erosion percentage test is calculated by dividing the taxpayer’s aggregate base erosion tax benefits for the tax year (deductions or reductions in gross income that result from base erosion payments as defined in proposed §1.59A-3(c)) by the sum of the aggregate amount of allowable deductions to the taxpayer, plus certain other base erosion tax benefits. In general, think simply of taking base erosion payments over all deductions to arrive at your base erosion percentage. Of course it can get complex figuring out the base erosion payments, and certain exceptions apply with regard to NOLs, the DRD, and the FDII/GILTI provisions as well. If you’ve met the first two applicable taxpayer tests, the proposed regulations can walk you through the base erosion percentage test in greater detail.
The average gross receipts and base erosion percentage tests are applied on an aggregate company group basis to determine if the taxpayer is a BEAT “applicable taxpayer”. Both domestic and foreign companies are considered in these calculations if the foreign company has effectively connected income (income that is effectively connected with the conduct of a U.S. trade or business). Aggregate, for these purposes, is defined in the proposed regulations using §1563 controlled group definitions, with the exception that the BEAT provision uses 50% rather than 80% as defined in the §1563(a)(1) definition. Once it’s determined the taxpayer is subject to the BEAT, modified taxable income and BEAT liability are computed on a stand-alone basis.
C Corporations with Partnership Investments
Partnerships are having to consider many tax reform items that on the surface may seem like they don’t apply. However, many C Corporations are invested in limited partnerships, and so it’s important for partnership return preparers to fully include items that may be pertinent to partners who may be subject to some of these new provisions. In turn, as a C Corporation partner, it’s important to carefully review K-1s for new items such as the BEAT that may need to be added into considerations at the corporate level.
As mentioned, partnerships are not subject to the BEAT themselves; the BEAT information is reported on the K-1 and is used for a determination at the partner level. §704 applies in that income and deductions of the partnership are considered that of the partner’s distributive share. Proposed regulation §1.59A-7(b)(5)(ii) states that each corporate partner must include its share of the partnership’s gross receipts for purposes of determining the applicable taxpayer gross receipts test.
However, an exception for smaller investments is given in proposed §1.59A-7(b)(4) for including a partner’s share of base erosion tax benefits if:
· The partner owns <10% of the capital and profits of the partnership,
· The partner owns <10% of the income, gain, loss, deduction and credits of the partnership, and
· The partner’s share of the partnership has a FMV <$25M on the last day of the partner’s taxable year, using a reasonable method.
In the case of tiered partnerships (the partner of a partnership is another partnership), the rules will apply successively until the partner is not a partnership.
New Form 8991 is required to be filed by each applicable taxpayer, not only those with a BEAT liability. To me, it’s been a little confusing in determining who is required to file this new form. The proposed regulations use the definition of an “applicable taxpayer” under §6043 as those required to file Form 8991, however, the Form Instructions ‘Who Must File’ requires any C Corporation with gross receipts of at least $500M in 1 or more of the last 3 preceding tax years must file. Maybe I’m missing something – if so, hey let me know!
In reviewing the Form 8991 and its instructions, it seems that if you are a C Corporation, and have gross receipts in excess of $500M, you’ll complete at least Part I which lays out if you are or are not an applicable taxpayer. If you don’t meet the base erosion percentage test, then you will not complete the remainder of the form.
Form 5472 may be required if reportable transactions exist related to base erosion payments and benefits and is filed by “reporting corporations”, which in general is a foreign owned entity.
Hopefully this high-level summary helped, and if not you can get into the weeds by checking out the 193 pages of proposed regulations REG-104259-18 which also contains examples and sections specifically related to insurance companies, banks, and consolidated groups. If you might be an applicable taxpayer subject to the BEAT, you better dig in - have fun!