On 6 December 2019, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) published in the Federal Register final regulations implementing the base erosion and anti-abuse tax (BEAT) under Section 59A. On the same date, Treasury also published in the Federal Register additional proposed regulations that provide guidance regarding BEAT. The final and proposed regulations affect corporations with substantial gross receipts that make certain payments to foreign related parties.
The final regulations retain the basic approach and structure of the proposed regulations (REG-104259-18) under Section 59A published on 21 December 2018, with certain revisions. For a summary discussion of the 2018 proposed regulations, see our December 2018 tax alert.
Some of the key modifications and highlights included in the final regulations are summarised below.
Gross receipts test and base erosion percentage test
The final regulations modify the rules in the 2018 proposed regulations for determining whether the gross receipts test and base erosion percentage test are satisfied for purposes of Section 59A with respect to a specific taxpayer when other members of its aggregate group have different taxable years. The final regulations provide that the determination of gross receipts and the base erosion percentage of a taxpayer’s aggregate group be made on the basis of the taxpayer’s taxable year and the taxable year of each member of its aggregate group that ends with or within the applicable taxpayer’s taxable year (the with-or-within method).[1]
The final regulations clarify that a transaction between parties is disregarded for purposes of Section 59A when determining the gross receipts and base erosion percentage of an aggregate group if both parties were members of the aggregate group at the time of the transaction, without regard to whether the parties were members of the aggregate group on the last day of the taxpayer’s taxable year.[2]
When determining the base erosion percentage of an aggregate group, the final regulations exclude the base erosion tax benefits and deductions attributable to the taxable year of a member of the aggregate group that begins before 1 January 2018.[3]
Definition of a base erosion payment
The final regulations clarify the definition of a base erosion payment in §1.59A-3(b)(1)(i) and (b)(2)(ix) to provide that a loss realised from the form of consideration provided to the foreign related party is not itself a base erosion payment. To the extent that a transfer of built-in-loss property results in a deductible payment to a foreign related party that is a base erosion payment, the final regulations clarify that the amount of the base erosion payment is limited to the fair market value of that property.
The final regulations generally exclude amounts transferred to, or exchanged with, a foreign related party in a transaction described in Sections 332, 351, and 368, or a corporate nonrecognition transaction, from the definition of a base erosion payment. This exception does not apply, however, to the transfer of other property, or property transferred in exchange for other property, in a corporate nonrecognition transaction.[4] An anti-abuse rule is also included to address nonrecognition transactions that could lead to inappropriate results in certain situations.[5] The final regulations, however, do not extend the exception for specified corporate nonrecognition transactions to partnership transactions because, as Treasury notes in the preamble, such treatment would generally be inconsistent with the approach of treating partners in a partnership as engaging in transactions with each other.
Treatment of distribution transactions
The final regulations also clarify the treatment of distribution transactions, such as distributions described in Section 301, and redemption transactions, such as redemptions described in Section 302.
A distribution with respect to stock for which there is no consideration (a pure distribution) is not treated as an exchange. Accordingly, the final regulations provide that a pure distribution of property made by a corporation to a shareholder with respect to its stock is not an amount paid or accrued by the shareholder to the corporation. These pure distributions include distributions under Section 301, without regard to the application of Section 301(c) to the shareholder (addressing distributions in excess of earnings and profits).[6]
However, unlike a pure distribution, a redemption of stock in exchange for property constitutes an exchange. Accordingly, the final regulations provide that a redemption of stock by a corporation within the meaning of Section 317(b) (such as a redemption described in Section 302(a) and (d) or Section 306(a)(2)), or an exchange of stock described in Section 304 or Section 331, is an amount paid or accrued by the shareholder to the corporation (or by the acquiring corporation to the transferor in a Section 304 transaction).
Other provisions
The final regulations provide that the additional 1% add-on to the BEAT rate will not apply to a taxpayer that is part of an affiliated group with de minimis banking and securities dealer activities.[7]
The final regulations provide that Section 15 only applies to the change in tax rate set forth in Section 59A(b)(2) and does not apply to the change in tax rate included in Section 59A(b)(1)(A) for taxable years beginning in calendar year 2018.
The final regulations provide a more detailed explanation of how the aggregate approach to partnerships and their partners set forth in the 2018 proposed regulations operates, including the treatment of partnership contributions and transfers of partnership interests (including issuances). In addition, §1.59A-7(g) includes examples illustrating the application of the rules.
The final regulations provide additional clarity and guidance with respect to the anti-abuse rules in §1.59A-9.
A number of other items are addressed in the final regulations, including allocation of interest.
The proposed regulations provide guidance under Sections 59A and 6031 regarding certain aspects of BEAT. Some of the key highlights to the proposed regulations are summarised below.
Aggregate group rules
The proposed regulations provide guidance regarding certain applications of the aggregate group rules in light of the with-or-within method from the final regulations. The proposed regulations provide that a taxpayer with a short taxable year must use a reasonable approach to determine the base erosion percentage of its aggregate group and whether the taxpayer or its aggregate group satisfies the gross receipts test and base erosion percentage in Section 59A. A reasonable approach should neither over-count nor under-count the gross receipts, base erosion tax benefits, and deductions of the aggregate group of the taxpayer.
To determine the gross receipts and the base erosion percentage of a taxpayer with respect to its aggregate group for purposes of Section 59A, the proposed regulations take into account only items of members that occur during the period that they were members of the taxpayer’s aggregate group.[8] Items of members that occur before a member joins an aggregate group of a taxpayer or after a member leaves an aggregate group of a taxpayer are not taken into account by the taxpayer. Solely for purposes of determining which items occurred while a corporation was a member of an aggregate group under Section 59A, a corporation is treated as having a deemed taxable year end when the corporation joins or leaves an aggregate group of a taxpayer. The taxpayer may determine items attributable to this deemed short taxable year by either deeming a close of the corporation’s books or, in the case of items other than extraordinary items (as defined in §1.1502-76(b)(2)(ii)(C)), making a pro-rata allocation.[9]
The proposed regulations clarify that, for purposes of Section 59A, if the taxpayer or any member of its aggregate group is also a predecessor of the taxpayer or any member of its aggregate group, the gross receipts, base erosion tax benefits, and deductions of each member are taken into account only once.[10]
Foregone deductions
The proposed regulations provide that a taxpayer may forego a deduction and that those foregone deductions will not be treated as a base erosion tax benefit if the taxpayer waives the deduction for all U.S. federal income tax purposes and follows specified procedures.[11] If the taxpayer waives a deduction for purposes of Section 59A, the proposed regulations provide that the taxpayer cannot claim the deduction for any purpose of the Internal Revenue Code or regulations except as otherwise provided under the proposed regulations.[12]
The proposed regulations also include certain reporting rules concerning deductions that are waived pursuant to the proposed regulations, and provide guidance on the time and manner for electing to waive deductions.[13] Various rules apply on how a taxpayer makes the election and there are rules to coordinate the waiver of the deduction with other provisions of the Code and regulations.
Partnership allocations and interests
To the extent the partnership places a taxpayer in an economically equivalent position by allocating less income to that partner in lieu of allocating a deduction to the partner through curative allocations, the proposed regulations provide that the partner is similarly treated as having a base erosion tax benefit to the extent of that substitute allocation.[14]
The proposed regulations provide an additional anti-abuse rule relating to derivatives on partnership interests.[15] The rule provides that a taxpayer is treated as having a direct interest in the partnership interest or asset if the taxpayer acquires a derivative on a partnership interest or asset with a principal purpose of eliminating or reducing a base erosion payment.
The proposed regulations also provide an additional anti-abuse rule to prevent a partnership from allocating items of income with a principal purpose of eliminating or reducing the base erosion payments to a taxpayer not acting in a partner capacity on amounts paid to or accrued by a partnership that do not change the economic arrangement of the partners.
In the preamble, Treasury notes that a domestic partnership and a reporting foreign partnership will be required to report the information required by Form 8991.[16]
Effective dates
The rules in the Section 59A proposed regulations generally apply to taxable years beginning on or after the date that final regulations are filed with the Federal Register. The rules in proposed §§1.59A-7(c)(5)(v) and (g)(2)(x) and 1.59A-9(b)(5) and (6) apply to taxable years ending on or after 6 December 2019. As proposed, the Section 59A regulations will permit taxpayers to apply the rules therein in their entirety for taxable years beginning after 31 December 2017, and before the regulations apply.[17]
If a taxpayer applies the 2018 proposed regulations to a taxable year ending on or before 6 December 2019, the determination as to whether the taxpayer is applying these proposed regulations in their entirety to such taxable year is made without regard to the application of §1.59A-2(c)(2)(ii), (c)(4), (c)(5), and (c)(6).
In addition, taxpayers may rely on the rules in the Section 59A proposed regulations in their entirety for taxable years beginning after 31 December 2017, and before the final regulations are applicable.
Monika Loving
mloving@bdo.com
Joe Calianno
jcalianno@bdo.com
[1] See §1.59A-2(c)(3) for additional details.
[2] See §1.59A-2(c)(1) for additional details.
[3] See §1.59A-2(c)(8) for additional details.
[4] Solely for purposes of determining what is a base erosion payment, “other property” has the meaning of other property or money, as used in Sections 351(b), 356(a)(1)(B), and 361(b), as applicable, including liabilities described in Section 357(b). However, other property does not include the sum of any money and the fair market value of any property to which Section 361(b)(3) applies. Other property also includes liabilities that are assumed by the taxpayer in a corporate nonrecognition transaction, but only to the extent of the amount of gain recognized under Section 357(c).
[5] See §1.59A-9(b)(4) for additional details.
[6] See §1.59A-3(b)(2)(ii) for additional details.
[7] See §1.59A-5(c)(2) for additional details.
[8] Proposed §1.59A-2(c)(4).
[9] See proposed §1.59A-2(c)(4). For an illustration of this proposed rule, see proposed §1.59A-2(f)(2), Example 2.
[10] Proposed §1.59A-2(c)(6)(ii).
[11] Proposed §1.59A-3(c)(6).
[12] See proposed §1.59A-3(c)(6)(ii).
[13] Proposed §1.59A-3(c)(6)(i) and (iii).
[14] Proposed §1.59A-7(b)(5)(v).
[15] See proposed §1.59A-9(b)(5).
[16] See §1.6031(a)-1(a) and (b)(1)(i).
[17] See section 7805(b)(7).