The IRS has issued final regs that provide guidance under Code Sec. 59A regarding the base erosion and anti-abuse tax (BEAT). The final regs address, among other things, aggregate groups, the BEAT waiver election, the application of the BEAT to partnerships, and an anti-abuse rule with respect to certain basis step-up transactions.
Background—Sec. 59A in general.
Under Code Sec. 59A, with respect to base erosion payments (as defined below) paid or accrued in tax years that begin after December 31, 2017, “applicable taxpayers” are required to pay a tax, the BEAT, equal to the “base erosion minimum tax amount” for the tax year. (Code Sec. 59A(a))
Applicable taxpayers are corporations (other than RICs, REITs, and S corporations) with average annual gross receipts of at least $500 million for the three-tax-year period ending with the preceding year and a “base erosion percentage” of at least 3% (2% for certain banks and securities dealers). (Code Sec. 59A(e))
The “base erosion percentage” for any tax year is equal to the aggregate amount of base erosion tax benefits of the taxpayer for the tax year divided by the aggregate amount of specified deductions allowable to the taxpayer for the tax year. (Code Sec. 59A(c)(4))
For purposes of determining a taxpayer’s gross receipts and base erosion percentage, pursuant to Code Sec. 59A(e)(3), corporations that are treated as a single employer under Code Sec. 52(a), which treats members of the “same controlled group of corporations” (as defined in Code Sec. 1563(a) with certain modifications) as one person, are aggregated for BEAT purposes under Code Sec. 59A(e)(3).
The base erosion minimum tax amount equals the excess of:
- A statutory percentage of the taxpayer’s modified taxable income over
- The taxpayer’s regular tax liability reduced by certain excess credits. (Code Sec. 59A(b)(1))
Modified taxable income means the taxable income of the taxpayer computed under Chapter 1 for the tax year, determined without regard to:
- Any base erosion tax benefit with respect to any base erosion payment, and
- The base erosion percentage of any net operating loss deduction allowed under Code Sec. 172 for the tax year.
(Code Sec. 59A(c)(1)) Generally, a base erosion tax benefit is any deduction that is allowed under Chapter 1 for the tax year for any base erosion payment. Base erosion tax benefits also include any deductions allowed for the tax year for depreciation or amortization with respect to the property acquired with payments described in Code Sec. 59A(d)(2). (Code Sec. 59A(c)(2))
A base erosion payment generally means any amount paid or accrued by an applicable taxpayer to a foreign person that is a related party of the taxpayer and with respect to which a deduction is allowable, including any amount paid or accrued by the taxpayer to the related party in connection with the acquisition by the taxpayer from the related party of property of a character subject to the allowance of depreciation (or amortization in lieu of depreciation). (Code Sec. 59A(d))
Background—proposed regs.
In December 2019, the IRS released proposed regs which addressed:
- How a taxpayer determines its aggregate group for purposes of determining gross receipts and the base erosion percentage;
- An election to waive deductions;
- The application of the BEAT to partnerships.
See Base erosion and anti-abuse tax prop regs address aggregate groups, other topics (12/04/2019).
The proposed regs would provide taxpayers an election to waive deductions that would otherwise be taken into account in determining whether the taxpayer is an applicable taxpayer subject to the BEAT (the “BEAT waiver election”). A taxpayer may forego a deduction and those foregone deductions would 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. (Prop Reg § 1.59A-3(c)(6))
Reasonable approach during short taxable year. Prop Reg §1.59A-2(c)(5) required a taxpayer with a taxable year of fewer than 12 months (a short taxable year) to annualize its gross receipts by multiplying the gross receipts for the short taxable year by 365 and dividing the result by the number of days in the short taxable year.
Prop Reg §1.59A-2(c)(5) also provided that a taxpayer with a short taxable year must use a reasonable approach to determine the gross receipts and base erosion percentage of its aggregate group members for the short taxable year.
Close of taxable year rule. The proposed regs provided guidance clarifying how the gross receipts and the base erosion percentage of an aggregate group are determined when members join or leave a taxpayer’s aggregate group, such as through a sale of the stock of a member to a third party. Prop Reg §1.59A-2(c)(4) provided that, in determining the gross receipts and the base erosion percentage of a taxpayer’s aggregate group, only items of members that occur during the period that they were members of the taxpayer’s aggregate group are taken into account. Under this rule (sometimes referred to as the “cut-off rule”) items of a member that occur before the member joins the aggregate group of the taxpayer or after the member leaves the aggregate group of the taxpayer are not taken into account in determining the gross receipts or base erosion percentage of the taxpayer’s aggregate group.
To implement this cut-off rule and determine which items occurred while a corporation was a member of a particular aggregate group, Prop Reg §1.59A-2(c)(4) treated a corporation that joins or leaves an aggregate group (in a transaction that does not otherwise result in a taxable year-end) as having a deemed taxable year-end. Specifically, Prop Reg §1.59A-2(c)(4) provided that this deemed taxable year-end occurs immediately before the corporation joins or leaves the aggregate group (“time-of-transaction rule”). The proposed regs permitted a taxpayer to 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 Reg §1.1502-76(b)(2)(ii)(C)), making a pro-rata allocation without a closing of the books.
Predecessors and successors. Prop Reg §1.59A-2(c)(6)(i) provided that, in determining gross receipts, any reference to a taxpayer includes a reference to any predecessor of the taxpayer, including the distributor or transferor corporation in a transaction described in Code Sec. 381(a) in which the taxpayer is the acquiring corporation.
To prevent over-counting, the proposed regs provided that, 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. (Prop Reg §1.59A-2(c)(6)(ii))
Eligibility for BEAT waiver election. Prop Reg §1.59A-3(c)(5) provided that the BEAT waiver election is the sole method by which a deduction that could be properly claimed by taxpayer for the taxable year is not taken into account for BEAT purposes (the “primacy rule”).
Prop Reg §1.59A-3(c)(6)(i) provided that, “[s]olely for purposes of paragraph (c)(1) of this section” (the definition of a base erosion tax benefit), the amount of allowed deductions is reduced by the amount of deductions that are properly waived.
Insurance premiums and the BEAT waiver election. The BEAT waiver election in the proposed regs specifically referenced deductions. (Prop Reg §1.59A-3(c)(6)) It was not clear the BEAT waiver election applies to insurance-related base erosion payments. (Preamble to TD 9910)
Application of the BEAT waiver election to partnerships. The BEAT waiver election did not expressly permit a waiver in connection with deductions that are allocated from a partnership. (Preamble to TD 9910)
Background—2019 final regs.
In December 2019, the IRS also issued final regs (the “2019 final regs”) regarding the BEAT. The 2019 final regs set forth operating rules for applying the BEAT to partnerships. In general, the final regs provide that a partnership is treated as an aggregate of its partners and, accordingly, deem certain transactions to have occurred at the partner level for BEAT purposes even though they may be treated as having occurred at the partnership level for other tax purposes. (Reg §1.59A-7) See IRS releases final regs implementing the base-erosion and anti-abuse tax (12/03/2019).
ECI exception. Generally, the 2019 final regs provide an exception (the “ECI exception”) whereby a base erosion payment does not result from amounts paid or accrued to a foreign related party that are subject to tax as income that is effectively connected with the conduct of a U.S. trade or business (ECI). (Reg §1.59A-3(b)(3)(iii))
The 2019 final regs do not set out specific rules for applying the ECI exception to transactions involving partnerships. (Preamble to TD 9910)
Anti-abuse rules of §1.59A-9 for basis step-up transactions. Code Sec. 59A(d)(2) generally defines a base erosion payment to include an amount paid or accrued to a foreign related party in connection with the acquisition of depreciable or amortizable property. However, Reg §1.59A-3(b)(3)(viii), adopted by the 2019 final regs, provides an exception to the definition of a base erosion payment for certain amounts transferred to or exchanged with a foreign related party in a transaction described in Code Sec. 332, Code Sec. 351, Code Sec. 355, and Code Sec. 368 (the “specified nonrecognition transaction exception”).
The 2019 final regs also adopted a specific targeted anti-abuse rule in Reg §1.59A-9(b)(4). That rule provides that if a transaction, plan, or arrangement has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a specified nonrecognition transaction, the nonrecognition exception of Reg §1.59A-3(b)(3)(viii)(A) will not apply to the nonrecognition transaction. Additionally, Reg §1.59A-9(b)(4) contains an irrebuttable presumption that a transaction, plan, or arrangement between related parties that increases the adjusted basis of property within the six-month period before the taxpayer acquires the property in a specified nonrecognition transaction has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a nonrecognition transaction.
Final reg modifications.
The final regs retain the basic approach and structure of the proposed regs, with certain revisions. (Preamble to TD 9910) In addition, the final regs revise some rules in the 2019 final regs.
Reasonable approach during short taxable year. The IRS was concerned that when a member does not have a taxable year that ends with or within a short taxable year of a taxpayer, some taxpayers may take the view that excluding the gross receipts, base erosion tax benefits, and deductions of the member from the taxpayer’s aggregate group is a reasonable approach under Prop Reg §1.59A-2(c)(5). The IRS does not view such exclusions as a reasonable approach. (Preamble to TD 9910)
Accordingly, the final regs clarify that such a method constitutes an unreasonable approach. In addition, to provide guidance for taxpayers in determining whether a particular approach is reasonable, the final regs include examples of methods that may or may not constitute a reasonable approach. (Reg §1.59A-2(c)(5)(i)(B))
Close of taxable year rule. The final regs provide that when a corporation has a deemed taxable year-end under Reg §1.59A-2(c)(4), the deemed taxable year-end is treated as occurring at the end of the day of the transaction. (Reg §1.59A-2(c)(4)(ii))
Thus, a new taxable year is deemed to begin at the beginning of the day after the transaction. A taxpayer determines items attributable to the deemed short taxable years ending upon and beginning the day after the deemed taxable year-end by either deeming a close of the corporation’s books or, in the case of items other than extraordinary items, making a pro-rata allocation without a closing of the books. (Reg §1.59A-2(c)(4)(iii))
Extraordinary items that occur on the day of, but after, the transaction that causes the corporation to join or leave the aggregate group are treated as occurring in the deemed taxable year beginning the next day. For this purpose, the term “extraordinary items” has the meaning provided in Reg §1.1502-76(b)(2)(ii)(C). This term is also expanded to include any other payment that is not made in the ordinary course of business and that would be treated as a base erosion payment. (Preamble to TD 9910)
A comment expressed concern that the deemed close of the taxable year that occurs when a member joins or leaves an aggregate group would create the potential for over-counting of gross receipts, base erosion tax benefits, and deductions of a member when applied in conjunction with the with-or-within method. This situation can arise when the taxpayer and a member of the aggregate group have different taxable years. (Preamble to TD 9910)
In response to this comment, Reg §1.59A-2(c)(5)(ii)(A) provides that, if a member of a taxpayer’s aggregate group has more than one taxable year that ends with or within the taxpayer’s taxable year and together those taxable years are comprised of more than 12 months, then the member’s gross receipts, base erosion tax benefits, and deductions for those years are annualized to 12 months for purposes of determining the gross receipts and base erosion percentage of the taxpayer’s aggregate group. To annualize, the amount is multiplied by 365 and the result is divided by the total number of days in the year or years.
The final regs also adopt a corresponding rule to address short taxable years of members. Specifically, if a member of the taxpayer’s aggregate group changes its taxable year-end, and as a result the member’s taxable year (or years) ending with or within the taxpayer’s taxable year is comprised of fewer than 12 months, then for purposes of determining the gross receipts and base erosion percentage of the taxpayer’s aggregate group, the member’s gross receipts, base erosion tax benefits, and deductions for that year (or years) are annualized to 12 months. This rule does not apply if the change in the taxable year-end is a result of the application of Reg §1.1502-76(a), which provides that new members of a consolidated group adopt the common parent’s taxable year. (Reg §1.59A-2(c)(5)(ii)(B))
The final regs also adopt a corresponding anti-abuse rule to address other types of transactions that may achieve a similar result of excluding gross receipts or base erosion percentage items of a taxpayer or a member of the taxpayer’s aggregate group that are undertaken with a principal purpose of avoiding applicable taxpayer status. (Reg §1.59A-2(c)(5)(iii))
Predecessors and successors. A comment recommended taking into account gross receipts of foreign predecessor corporations only to the extent the gross receipts are taken into account in determining ECI of the foreign predecessor corporation, which would be consistent with the ECI rule for gross receipts of foreign corporations in Reg §1.59A-2(d). (Preamble to TD 9910)
The final regs adopt this comment. Reg §1.59A-2(c)(6)(i) clarifies that the operating rules set forth in Reg §1.59A-2(c) (aggregation rules) and Reg §1.59A-2(d) (gross receipts test) apply to the same extent in the context of the predecessor rule. Thus, the ECI limitation on gross receipts in Reg §1.59A-2(d)(3) continues to apply to the successor. (Preamble to TD 9910)
Eligibility for BEAT waiver election. The final regs explicitly clarify that, in order to make or increase the BEAT waiver election under Reg §1.59A-3(c)(6), the taxpayer must determine that the taxpayer could be an applicable taxpayer for BEAT purposes but for the BEAT waiver election. (Reg §1.59A-3(c)(6)(i)) Thus, for example, a controlled foreign corporation that does not have ECI cannot make a BEAT waiver election because the controlled foreign corporation cannot be an applicable taxpayer. (Preamble to TD 9910)
In addition, when a taxpayer does not make a BEAT waiver election (or when this waiver is not permitted), Reg §1.59A-3(c)(5) and Reg §1.59A-3(c)(6)(i) have no bearing on whether or how a taxpayer’s failure to claim an allowable deduction, or to otherwise “waive” a deduction, is respected or taken into account for tax purposes other than Code Sec. 59A. In other words, the BEAT waiver election should not affect any existing law addressing “waiver” outside of the specific situation covered by the BEAT waiver (electing not to claim a deduction in order to avoid applicable taxpayer status). (Preamble to TD 9910)
Insurance premiums and the BEAT waiver election. The BEAT waiver election affects the base erosion tax benefits of the taxpayer, not the amount of premium that the taxpayer pays to a foreign insurer or reinsurer (or the amount received by that foreign insurer or reinsurer); therefore, for example, the waiver of reduction to gross premiums and other consideration (or of premium payments that are deductions for federal income tax purposes) does not reduce the amount of any insurance premium payments that are subject to insurance excise tax under Code Sec. 4371. (Preamble to TD 9910)
Application of the BEAT waiver election to partnerships. Subject to certain special rules in connection with the centralized partnership audit regime enacted in the Bipartisan Budget Act of 2015 (the “BBA”), the final regs explicitly permit a corporate partner in a partnership to make a BEAT waiver election with respect to partnership items. (Reg §1.59A-3(c)(6)(iv)(A))
The final regs also clarify that a partnership may not make a BEAT waiver election. (Reg §1.59A-3(c)(6)(iv)(A))
In addition, the final regs provide that waived deductions are treated as non-deductible expenditures under Code Sec. 705(a)(2)(B). (Reg §1.59A-3(c)(6)(iv)(B))
Further, the final regs provide rules to conform the partner-level waiver with Code Sec. 163(j) (the business interest deduction limitation). (Reg §1.59A-3(c)(6)(iv)(C)) Specifically, the final regs clarify that, when a partner waives a deduction that was taken into account by the partnership to reduce the partnership’s adjusted taxable income for purposes of determining the partnership-level section 163(j) limitation, the increase in the partner’s income resulting from the waiver is treated as a partner basis item (as defined in Reg §1.163(j)-6(b)(2)) for the partner, but not the partnership. Thus, the increase in the partner’s income resulting from the waiver is added to the partner’s section 163(j) limitation computation. (Reg §1.59A-3(c)(6)(iv)(C)) The partnership’s section 163(j) computations are not impacted by the partner’s waiver. (Preamble to TD 9910)
The final regs clarify that a partner may make the BEAT waiver election with respect to an increase in a deduction that is attributable to an adjustment made under the BBA audit procedures, but only if the partner is taking into account the partnership adjustments either because the partnership elects to have the partners take into account the adjustments under Code Sec. 6226 or Code Sec. 6227, or because the partner takes into account the adjustments as part of an amended return filed pursuant to Code Sec. 6225(c)(2)(A). (Reg §1.59A-3(c)(6)(iv)(D))
If the partner makes the BEAT waiver election, the partner will compute its additional reporting year tax (as described in Reg §301.6226-3) or the amount due under Reg §301.6225-2(d)(2)(ii)(A), treating the waived amount as provided in Reg §1.59A-3(c)(6). (Preamble to TD 9910)
The final regs do not address the interaction of the BBA audit procedures and the BEAT more generally. As the BBA audit procedures continue to be implemented, the IRS will review the implementation and determine whether future BBA audit procedure guidance is required with respect to BEAT. (Preamble to TD 9910)
ECI exception. The final regs revise Reg §1.59A-3(b)(3)(iii)(C) of the 2019 final regs to expand the ECI exception to apply to certain partnership transactions. The expanded ECI exception in Reg §1.59A-3(b)(3)(iii)(C) applies if the exception in Reg §1.59A-3(b)(3)(iii)(A) or Reg §1.59A-3(b)(3)(iii)(B) would have applied to the payment or accrual as characterized under Reg §1.59A-7(b) and Reg §1.59A-7(c) for purposes of Code Sec. 59A (assuming any necessary withholding certificate were obtained).
Anti-abuse rules of §1.59A-9 for basis step-up transactions. A comment stated that the anti-abuse rule can create a “cliff effect” whereby a minimal amount of pre-transaction basis step-up could disqualify an entire transaction that would have otherwise qualified for the specified nonrecognition transaction exception. The comment recommended that the anti-abuse rule exclude transactions with a relatively small amount of basis step-up or provide taxpayers with an election to forego the basis step-up. (Preamble to TD 9910)
The final regs revise Reg §1.59A-9(b)(4) to adopt this comment. First, the anti-abuse rule now provides that when the rule applies, its effect is to turn off the application of the specified nonrecognition transaction exception only to the extent of the basis step-up amount. The IRS says thi revision addresses the comment’s concern regarding the cliff effect of the rule.
Second, unrelated to cliff effect issue, Reg §1.59A-9(b)(4) has been revised to clarify that the transaction, plan, or arrangement with a principal purpose of increasing the adjusted basis of property must also have a connection to the acquisition of the property by the taxpayer in a specified nonrecognition transaction.
Applicable date.
The final regs generally apply to taxable years beginning on or after the date they are published in the Federal Register. Reg §1.59A-7(c)(5)(v), Reg §1.59A-7(g)(2)(x), Reg §1.59A-9(b)(5), and Reg §1.59A-9(b)(6) apply to taxable years ending on or after December 2, 2019. (Preamble to TD 9910)
Taxpayers may apply the final regs in their entirety for taxable years beginning after December 31, 2017, and before their applicability date, provided that, once applied, taxpayers must continue to apply these regs in their entirety for all subsequent taxable years. (Preamble to TD 9910)
Alternatively, taxpayers may apply only Reg §1.59A-3(c)(5) and Reg §1.59A-3(c)(6) for taxable years beginning after December 31, 2017, and before their applicability date, provided that, once applied, taxpayers must continue to apply Reg §1.59A-3(c)(5) and Reg §1.59A-3(c)(6) in their entirety for all subsequent taxable years. (Preamble to TD 9910)
Taxpayers may also rely on Prop Reg §1.59A-2(c)(2)(ii) and Prop Reg §1.59A-2(c)(4) through Prop Reg §1.59A-2(c)(6), and Prop Reg §1.59A-3(c)(5) and Prop Reg §1.59A-3 (c)(6) in their entirety for taxable years beginning after December 31, 2017, and before the date the final regs are published in the Federal Register. (Preamble to TD 9910)
Observation.
As of September 2, 2020, the final regs have not been published in the Federal Register. And the reg text does contain a publication date.
To continue your research on the base erosion and anti-abuse tax, see FTC 2d/FIN ¶D-1250 et seq., United States Tax Reporter ¶59A4.
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