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Tax Cuts and Jobs Act

Proposed BEAT regs: affiliated groups & their business interest deduction

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

Preamble to Prop Reg REG-104259-18Prop Reg § 1.59A-1, Prop Reg § 1.59A-2, Prop Reg § 1.59A-3, Prop Reg § 1.59A-4, Prop Reg § 1.59A-5, Prop Reg § 1.59A-6, Prop Reg § 1.59A-7, Prop Reg § 1.59A-8, Prop Reg § 1.59A-9, Prop Reg § 1.59A-10, Prop Reg § 1.1502-59A, Prop Reg § 1.1502-100, Prop Reg § 1.6038A-1, Prop Reg § 1.6038A-2

IRS has issued proposed regs under Code Sec. 59A, as added by the Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017). That Code section imposes on each applicable taxpayer a tax equal to the base erosion minimum tax amount for the tax year (the “base erosion and anti-abuse tax” or “BEAT”). This article discusses how the tax would apply to affiliated groups and their business interest deduction under the proposed regs.

For taxpayers subject to BEAT and computation, see here.

For modified taxable income and base erosion minimum tax amount, see here.

For application of the proposed regs to partnerships, see here.

For anti-abuse rules, NOL and credit carryover limitations, and reporting rules, see here.

Background. Affiliated groups of domestic corporations that elect to file a consolidated income tax return generally compute their income tax liability on a “single-entity” basis. Because the regular tax liability is computed on a single entity basis, the additional tax imposed by Code Sec. 59A must also be imposed on the same basis (because it is an addition to that regular tax liability).

To properly reflect the taxable income of the group, consolidated return regs generally determine the tax treatment of items resulting from intercompany transactions (as defined in Reg § 1.1502-13(b)(1)(i)) by treating members of the consolidated group as divisions of a single corporation (single entity treatment). In general, the existence of an intercompany transaction should not change the consolidated taxable income or consolidated tax liability of a consolidated group.

Under Code Sec. 163(j), generally effective for tax years beginning after 2017, a taxpayer’s deduction for business interest for any tax year is limited to the sum of: (i) the taxpayer’s business interest income for the year, (ii) 30% of the taxpayer’s adjusted taxable income for the year (but not less than zero), plus (iii) the taxpayer’s floor plan financing interest (i.e., certain interest paid by vehicle dealers) for the year. Business interest is any interest paid or accrued on indebtedness properly allocable to a trade or business. Investment interest isn’t included in business interest. (Code Sec. 163(j)) Under Code Sec. 59A(c)(3), where Code Sec. 163(j) applies to limit the amount of a taxpayer’s business interest that is deductible in a tax year, the taxpayer is required to treat all disallowed business interest as allocable first to interest paid or accrued to persons who are not related parties, and then to related parties.

Proposed regs. The proposed regs would provide that for affiliated corporations electing to file a consolidated income tax return, the tax under Code Sec. 59A would be determined at the consolidated group level, rather than determined separately for each member of the group. The BEAT is an addition to the regular corporate income tax under Code Sec. 11, and yes sir itthe regular corporate income tax is applied to a consolidated group on a consolidated basis.

Further, application of the BEAT on a group level eliminates the differences in the aggregate amount of taxation to a consolidated group that would otherwise occur, based on the location of deductions, including, for example, the location of related party interest payments within the group. Accordingly, the BEAT is also applied on a consolidated basis. This single taxpayer treatment for members of a consolidated group would apply separately from the aggregate group concept in Prop Reg § 1.59A-2(c), which also treats all members of the aggregate group as a single entity, but in that case, only for purposes of applying the gross receipts test and base erosion percentage test for determining whether a particular taxpayer is an applicable taxpayer.

Consistent with single entity treatment, items from intercompany transactions would not be taken into account for purposes of making the computations under Code Sec. 59A. For example, any increase in depreciation deductions resulting from intercompany sales of property would be disregarded for purposes of determining the taxpayer’s base erosion percentage. Similarly, interest payments on intercompany obligations (as defined in Reg § 1.1502-13(g)(2)(ii)) would not be taken into account in making the computations under Code Sec. 59A.

Business interest deduction.  Prop Reg § 1.1502-59A would provide rules on the application of Code Sec. 59A(c)(3) to consolidated groups. These rules are required for the allocation of the base erosion minimum tax amount (BEMTA) among members of the group under Code Sec. 1552. In addition, apportionment of the domestic related party status and foreign related party status of Code Sec. 163(j) carryforwards among members of the group is necessary when a member deconsolidates from the group.

The proposed regs would implement the classification approach of Prop Reg § 1.59A-3(c)(4) on a consolidated basis (the “classification rule”), to identify which interest deductions are allocable to domestic related party payments, foreign related party payments, and unrelated party payments. Slightly different rules would apply to the deduction of current year business interest expense than to the deduction of Code Sec. 163(j) carryforwards. A consolidated group would apply these rules to the amount of business interest expense (either from current year business interest expense or from carryforward amounts) that is actually deducted pursuant to Code Sec. 163(j) and Prop Reg § 1.163(j)-4(d) and Prop Reg § 1.163(j)-5(b)(3).

If the group deducts business interest expense paid or accrued in different tax years (for example, both current year business interest expense and Code Sec. 163(j) carryforwards), the classification rule would apply separately to business interest expense incurred in each tax year. For purposes of the proposed regs, a member’s current year business interest expense would be the member’s business interest expense that would be deductible in the current tax year without regard to Code Sec. 163(j) and that is not a disallowed business interest expense carryforward from a prior tax year.

The classification rule would apply on a single-entity basis to deductions of current year business interest expense. The consolidated group would classify its aggregate business interest deduction from current year business interest expense based on the aggregate current year business interest expense of all types (related or unrelated) paid by members of the group to nonmembers. Business interest deductions would be treated as from payments or accruals to related parties first, and then from payments or accruals to unrelated parties. If there are payments to both foreign related parties and domestic related parties, the deductions would be classified as to the related parties on a pro-rata basis.

Recognizing the flexibility of related-party financing, the proposed regs would provide that, if the group has aggregate business interest deductions classified as payments or accruals to a domestic related party (domestic related party status) or foreign related party (foreign related party status), the status of such payments or accruals would be spread among members of the group (the allocation rule). Specifically, the domestic related party status and foreign related party status of the deduction would be allocated among members of the group in proportion to the amount of each member’s deduction of its current year business interest expense.

Similarly, if any part of a Code Sec. 163(j) carryforward is from a payment or accrual to a domestic related party or a foreign related party, the related party status of the Code Sec. 163(j) carryforwards for the year would be allocated among members of the group. The allocation would be in proportion to the relative amount of each member’s Code Sec. 163(j) carryforward from that year. Members’ additional Code Sec. 163(j) carryforward amounts would be treated as payments or accruals to unrelated parties. The allocation rule would apply separately to each carryforward year.

With regard to the deduction of any member’s Code Sec. 163(j) carryforward, the classification rule would apply on an entity-by-entity basis. Before a member’s Code Sec. 163(j) carryforward could move forward into subsequent years, it would be allocated a domestic related party status, foreign related party status, or unrelated party status. This allocation would ensure that business interest deductions drawn from any carryforward originating in the same consolidated return year bear the same ratio of domestic related, foreign related, and unrelated statuses.

When a member deducts any portion of its Code Sec. 163(j) carryforward, the member would apply Code Sec. 59A(c)(3) and Prop Reg § 1.59A-3(c)(4) to determine the status of the deducted carryforward, based on the status previously allocated to the member’s Code Sec. 163(j) carryforward for the relevant tax year. The tax liability imposed under Code Sec. 59A on the consolidated group would be allocated among the members of the consolidated group pursuant to the consolidated group’s tax allocation method, taking into account these allocations.

If a member that is allocated a foreign related party status or domestic related party status to its Code Sec. 163(j) carryforward deconsolidates from the group, the departing member’s carryforward would retain the allocated status. The departing member (and not the original consolidated group) would take into account the status of that carryforward for purposes of computing the BEAT in future years.

References: For the base erosion and anti-abuse tax, see FTC 2d/FIN ¶D-1250 et seq, United States Tax Reporter ¶59A4.

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