UNDERSTANDING THE NEW BEAT TAX

Transcription

1 TEI HOUSTON CHAPTER: FEDERAL UPDATE UNDERSTANDING THE NEW BEAT TAX F. SCOTT FARMER PETER M. DAUB MORGAN LEWIS FEBRUARY 26, 2018

2 BEAT -- General Rules Base erosion anti-abuse tax ( BEAT, Code Section 59A) imposes tax on an applicable taxpayer equal to the base erosion minimum tax amount ( BEMTA ), calculated as equal to the excess of (1) 10% (5% for 2018, 12.5% beginning after 2025) of modified taxable income ( MTI ) over (b) regular tax liability ( RTL ) net of certain credits Rates for banks and securities dealers are 1% higher: 6% in 2018, 11% through 2025 and 13.5% thereafter MTI is generally taxable income increased by adding back deductions for payments to and depreciation and amortization for property acquired from foreign related persons and reductions in and deductions from gross re-insurance premiums paid to such persons RTL is reduced by all tax credits other than the R&D credit and 80% of three categories of credits (not including FTC) Applies to domestic corporations and foreign corporations with effectively connected income (ECI), regardless of whether such corporations are part of a U.S.-owned or a foreign-owned group In addition to regular tax liability cannot be offset by credits (tax imposed in new section 59A rather than section 11; see section 26(b)(2)(B)) not creditable in future against regular tax liability Cf. former corporate AMT Effective for payments paid or accrued in taxable years beginning after

3 Key Terms Applicable Taxpayer Modified Taxable Income Base Erosion Benefits/Payments Foreign Related Person Base Erosion Percentage Regular tax liability 3

4 Who is Subject to BEAT: Applicable Taxpayer BEAT applies only to an applicable taxpayer, defined as a corporation (other than RIC, REIT, or S corporation) with substantial gross receipts (average annual gross receipts for the 3-year period ending with the preceding taxable year are at least $500 million) and generally more than a de minimis amount (3%) of the add-backs to taxable income in computing MTI as a percentage of the sum of all such-add backs and other deductions for the year (referred to as the base erosion percentage, defined more precisely below) 2% for a bank or securities dealer What is included in gross receipts not defined Cliff effects of exceptions Exceptions applied on annual basis and computed on a group basis Single employer aggregation under section 52 In applying section 1563 for purposes of section 52, the exception for foreign corporations is disregarded Applicable taxpayer can be a domestic or foreign corporation with ECI Gross receipts of foreign corporations included only to the extent included in computing ECI 4

5 What Constitutes Modified Taxable Income 10% of MTI must exceed RTL net of certain credits for BEAT to apply; thus MTI is a key component the larger the MTI, the greater the likelihood that BEAT applies MTI is defined as taxable income of the applicable taxpayer for the taxable year, adding back (1) base erosion tax benefits -- base erosion payments that given rise in current year to allowable deductions or certain reductions in gross income or gross receipts for the year Added back even if no current year benefit (because loss without regard to the base erosion payments), and (2) the base erosion percentage of any NOL deduction allowed under section 172 for the current year Note, if applicable taxpayer s taxable income is reduced more than 52% by base erosion payments, BEAT may impose additional tax. Cf. 50% ATI in prior 163(j) 5

6 Base Erosion Payments Base erosion payment includes any amount paid or accrued by the taxpayer to foreign person that is a related party for which a deduction is otherwise currently allowed For example, payments for rents, royalties, services, captive insurance Includes interest payments as well Interest for which deductions deferred under 163(j) stacked first to interest paid to unrelated persons Banks or other financial companies provided no special treatment Foreign tax treatment irrelevant Inclusion in Subpart F income or GILTI irrelevant (cf. old Section 163(j) regulations) Treatment as ECI irrelevant Depreciation/amortization deductions with respect to property acquired by taxpayer from a related person with an amount paid or accrued by the taxpayer to the related foreign person (e.g., machinery, intangibles acquired by purchase) Reductions in income for re-insurance premiums paid to related foreign person Reductions from gross receipts (e.g., cost of goods sold) as a result of amounts paid or accrued to related post- 11/9/17 inverters 6

7 Foreign Related Person Foreign person defined by reference to section 6038A(c)(3) Thus foreign partnership or foreign trust included Related person defined broadly 25% relatedness threshold /section 482 Constructive ownership 7

8 Exclusions from Base Erosion Payment Exceptions for Cost of goods sold on payments to related foreign persons other than related post-11/9/17 inverters Amounts to the extent U.S. tax withheld on base erosion payment under section 1441 or 1442 If reduced withholding tax applies (e.g. treaty), only the percentage of the total amount subject to withholding is excluded Qualified derivative payments but to qualify Taxpayer must mark to market derivative on last day of taxable year, treat gain/loss as ordinary, treat all items of income, deduction, gain, or loss with respect to payment as ordinary Derivative includes any contract the value of which/payment with respect to which determined by reference to any rate, price, amount, index, formula or algorithm But exclusion does not apply to a payment that would be a base erosion payment if it weren t made pursuant to a derivative, including interest, royalty, or services payment Unless qualified derivative payments exception satisfied, applies to all types of deductible financial payments to foreign related person 8

9 Certain Services Exception for amounts paid for certain cost method services An amount paid or accrued for services if (a) services meet requirements for eligibility of the section 482 services cost method (without regard to requirement that services not contribute significantly to fundamental risks of business success or failure) and (b) amount constitutes total services cost with no markup component Portman/Hatch colloquy and subsequent Conference Committee language Based on statute and legislative history may be possible to bifurcate service fees into cost and mark-up components, with BEAT applying only to markup component Foreign tax implications of such structuring? Recent articles and legislative staff reach varying conclusions Future guidance will be needed to resolve this important issue 9

10 Base Erosion Percentage Important in determining whether the 3% (or 2%) de minimis exception from the definition of an applicable taxpayer applies and the amount of any NOL deduction that is added back in computing MTI Base erosion percentage determined by dividing Aggregate amount of base erosion tax benefits (as defined above, generally base erosion payments that give rise to deduction or reduction of gross income or gross receipts) for the taxable year, by The sum of the aggregate amount of all deductions for the taxable year, taking into account base erosion tax benefits (including reductions of gross income/receipts) but not taking into account any deduction under sections 172, 245A, or 250, or any deduction for amounts that qualify for exceptions for services and qualified derivative payments (that are excluded from base erosion payments) Note, no exclusion from numerator or denominator of payments subject to U.S. tax due to, e.g., ECI, GILTI, Subpart F Section 243 and 245 deductions appear to be included in the denominator Treaty-benefited payments included in both numerator and denominator Impact of single employer aggregation rule? 10

11 Regular Tax Liability Regular tax liability is tax liability as determined under section 26(b), which is generally tax imposed by section 11. RTL must be reduced by most credits (including FTC) ( reducing credits ), thereby making the BEAT s application more likely But until 2026 RTL not reduced by research credit and 80% of three categories of applicable section 38 credits (not reducing credits) Three categories of section 38 credits are Low-income housing credit under section 42(a) Renewable electricity production credit under section 45(a) Investment credit under section 46 to the extent allocable to the energy credit determined under section 48 For taxable years beginning after 2025, credits reduce RTL in full, thereby increasing the likelihood of the tax applying Note, to the extent that credits reduce RTL the greater the likelihood that 10% of MTI will exceed the RTL net of reducing credits and thus that BEAT will apply if credits reduce RTL by more than 52%, BEAT is highly likely to apply, because RTL net of reducing credits reduced below 10% of MTI 11

12 Overview of BEMTA Computation Start with Taxable Income Add Base Erosion Tax Benefits Add Base Erosion % of NOL Deduction Equals Modified Taxable Income Multiple by 10% 10% of Modified Taxable Income Subtract Regular Tax Liability Netof Reducing Credits Equals Base Erosion Minimum Tax Amount 12

13 Simple Example 1 -- Single Applicable Taxpayer, Positive Taxable Income, No NOL Carryovers, No Credits $300 G.I. -$200 BETB 0 Other deductions $100 T.I. 21% Tax Rate 0 Credits $21 RTL MTI $300 10% of MTI $30 RTL net of credits $21 BEMTA $9 Total Tax $30 13

14 Example 2 Impact of Increasing Gross Income Assume the same facts in Example 1 except that gross income is increased from $300 to $301 or to $382 At $301, total U.S. tax goes from $30 to $ % of MTI = $30.1, RTL = $21.2 (21% x $101), BEMTA = $8.9 ($ $21.2), total U.S. tax = $30.1 At $382, total U.S. tax goes from $30 to $ % of MTI = $38.2, RTL = $38.2 (21% x 182), BEMTA = 0 ($ $38.2), total U.S. tax = $38.2 As this illustrates, each additional dollar of gross income from $301 to $381 taxed at a 10% marginal rate because 10% of MTI exceeds RTL and BEMTA applies (with no graduation) at 10%; when gross income equals or exceeds $382, overall U.S. tax rate stabilizes at 21% (as 10% of MTI doesn t exceed RTL) Same result occurs if, instead, there been non-base erosion deductions that were deferred rather than currently deductible (e.g., interest subject to 163(j)), as taxable income would increase by same amounts, so that 10% of MTI would exceed RTL up to $382 Note, however, if the facts in Example 1 exist in each of two consecutive years, except that $82 of gross income is accelerated from year 2 to year 1, no net benefit achieved over the two-year period, as illustrated by Example 3 14

15 Example 3-- Acceleration $82 of Gross Income From Year 2 to Year 1 Year 1 Year 2 $382 G.I. $218 G.I. -$200 BETB -$200 BETB $0 Other deductions $0 Other deductions $182 T.I. $18 T.I. 21% Tax Rate 21% Tax Rate 0 Credits 0 Credits $38.2 RTL $3.8 RTL MTI $382 MTI $218 10% OF MTI $ % OF MTI $21.8 RTL $38.2 RTL $3.8 BETMA 0 BETMA $18 Total Tax $38.2 Total Tax $

16 Impact of Current Year Losses MTI is defined as taxable income with certain add backs for base erosion payments to related parties Thus, one issue is whether a taxpayer with a taxable year loss will be considered to have zero taxable income or negative taxable income (a taxable loss) Note, a current year loss will generate a NOL deduction in future years, the base erosion percentage of which is added back in determining MTI in such years Note further, assuming that the taxpayer starts the computation with a taxable loss, it may have no MTI, as the total could still be negative even when adding back base erosion tax benefits But if MTI is positive, BEAT will apply, as RTL will be zero and thus 10% of MTI will exceed RTL 16

17 Impact of NOL Deductions In calculating MTI, the base erosion percentage of any NOL deduction allowed under section 172 for the taxable year is added back This provision raises a number of important issues, such as: whether the base erosion percentage is determined by reference to the current year in which the NOL deduction is taken or the year(s) in which the NOL was created whether pre-2018 NOL deductions are included even though BEAT did not apply in those years Note, BEAT provisions provide for no special transition rule for NOLs Transition issue is particularly important if consolidated group has large NOL carryovers, but the applicable taxpayer does not, and the rules are applied on a consolidated basis 17

18 Combined Impact of NOL (and Current Year Losses) on New Provisions Not only can NOL (and current year losses) increase the likelihood of BEAT (because reduces RTL) but they also reduce or eliminate section 250 deductions (limited by taxable income) on GILTI and FDII and deny FTCs on GILTI (as no carryover) Similarly, GILTI and section 250 do not address how those rules operate where a consolidated return is filled BEAT cannot be analyzed in isolation 18

19 Impact of FTCs And Other Reducing Credits FTCs reduce RTL Thus FTCs used to offset U.S. tax on GILTI, foreign branch income, Subpart F income or other general limitation income (including caused by ODL recapture) reduces RTL and thus increases the likelihood of BEAT Other reducing credits have similar impacts Note, after 2025, all credits reduce RTL!!! If RTL is reduced by more than 52%, BEAT likely to apply 19

20 No Express Netting Rule If a U.S. company enters into a cross licenses in which payments are both received from and made to a foreign related person (or persons), BEAT has no express rule that allows for the two amounts to be netted Similarly, if the U.S. company enters into a license from a related CFC and the income is included as Subpart F income, BEAT has no express rule that allows the payment to the CFC and the Subpart F income to be netted Captive insurance arrangements in which premiums and recoveries are netted by contract; payments on securities loans; other payments netted by contract Payments that Code or regulations net (payments on notional principal contracts, buy-in and ongoing payments in cost-sharing arrangements) 20

21 No Express Look-thru Rule for Unrelated Party Payments If a foreign corporation acts a service hub for the acquisition of third party services for the worldwide group, BEAT has no express rule that treats any portion of the service fee paid by the U.S. to the foreign corporation as unrelated party costs. Similarly, if a foreign group borrows from an unrelated party and on-lends to the U.S. at a spread overs its borrowing costs, BEAT provides for no express rule that treats any portion of the interest paid by the U.S. as unrelated party costs Cf. provision in conduit regulations prohibiting affirmative use 21

22 Other Distinctions US-distributor that buys products where the intangible is bundled into the cost of the product from a foreign related person is not subject to BEAT because of the COGS exception But a US-distributor that licenses intangibles from a foreign related person to distribute products is, unless the royalty payments constitute COGS If a foreign group forms a Canadian subsidiary to purchase machinery, equipment and intangibles from foreign related persons and make and sell products into the U.S. through a U.S. related party distributor, BEAT does not apply to any of the payments made by the Canadian subsidiary as it is a foreign corporation (assuming no PE) But if the same foreign group forms a U.S. subsidiary in Michigan to conduct the same activities, the payments to related persons by the U.S. subsidiary are subject to BEAT, unless the payments constitute COGS A foreign group that centralizes third party borrowing outside the U.S. and on-lends to U.S. subsidiaries that makes interest payments that are otherwise not denied under section 163(j) is subject to BEAT But interest paid by a U.S. subsidiary of a foreign group that borrows from a third party with a foreign parent guarantee is not (although any amount paid for the guarantee would be) Many other similar situations 22

23 Interaction of BEAT With Other New Provisions Section 163(j) interest expense deduction limitations As noted, interest not denied under section 163)(j) still subject to BEAT (with denied interest first stacked against unrelated party interest) The GILTI provisions As noted, FTCs used to offset U.S. tax on GILTI increase the likelihood of BEAT More unrelated party interest deductible under section 163(j), more section 168(k) bonus depreciation greater the likelihood that the 3% de minimis test applies (as denominator of base erosion percentage is increased) but also greater the likelihood that NOLs or current year losses are created, which could produce the problems noted above BEAT cannot be analyzed in isolation 23

24 Additional Issues Whether BEAT will apply on a consolidated basis for groups that file consolidated U.S. federal income tax returns Government officials have tentatively said that it should How rules will apply where partnerships are involved How inter-branch payments/allocations will apply to foreign corporations with ECI Interaction with cost-sharing rules E.g., Does cost-sharing result in base erosion payments to the extent of outbound cost sharing payments to foreign R&D function? Treatment of groups that include a bank or securities dealer (affiliated group vs. controlled group below 80% threshold for affiliation) Whether BEAT violates treaty non-discrimination article and how disputes on this issue will be resolved 24

25 Road Map for Planning Identifying transactions that could be subject to the BEAT Performing detailed computational modeling of the BEAT and other provisions of the Code that interact with BEAT Consider if gross receipts exception applies If not, consider if 3% (or 2%) de minimis exception applies For large groups, if credits (FTC, etc.) reduce RTL by more than 52%, satisfying the de minimis exception likely to be particularly important Consider evaluating operating models and business practices, such as arrangements set up for the convenience of a client or customer, and accounting and foreign tax treatment of payments to determine whether BEAT exposure could be reduced By either satisfying gross receipts or de minimis exceptions or managing income and expenses to keep the 10% MTI threshold below RTL through various techniques discuss below 25

26 Planning Considerations Reduce amount of deductible payment by avoiding deductible payments Plan into COGS exception Purchase finished product from foreign affiliate (perhaps acting as contract manufacturer for foreign affiliate but see section 956) rather than license intangibles owned by foreign affiliate and manufacture Analyze all related party payments to determine if a change can be made to categorizing certain of these payments as inventoriable items E.g., determine if services fee paid to contract manufacturer or other (or fees from other service arrangements) can be included in inventoriable costs Note, that a change to characterization of a non-inventoriable item is likely to cause a change in method of accounting, requiring consent from the IRS 26

27 Planning Considerations Related to unrelated Third party borrowing/license (with parent guaranty) rather than back-to-back borrowing/licenses from foreign parent Cf. old Section 163(j) Pay unrelated parties directly rather than include in cost that it pays to related foreign person Reduce amount of deductible payments through netting Cross-licenses? Net amounts generally Cf. Section 871(m)(5) ( the term payment includes any gross amount which is used in computing any net amount which is transferred to or from the taxpayer ) 27

28 Planning Considerations Review all techniques for accelerating income or deferring deductions to exploit the 3% threshold or reduce MTI (or increase RTL) so that 10% of MTI does not exceed RTL reduced by reducing credits E.g. consider making section 59(e) election to capitalize IDC, or electing out of section 168K bonus deprecation for certain properties Need to be monitor on annual basis, as Examples 1 and 3 demonstrate Note, because the tax law generally favors taxpayer accelerating income and deferring deductions, it will be interesting to see how the system reacts to taxpayer that now may have reasons to affirmatively use these rules to obtain significant tax benefits 28

29 Cautionary Concerns Regulations to prevent the avoidance of the purposes of the BEAT through: the use of unrelated persons, conduit transactions, or other intermediaries arrangements designed, in whole or in part to characterize payments otherwise subject to the BEAT as payments not subject to the BEAT to substitute payments not subject to the BEAT for payments otherwise subject to the BEAT What is the scope of these anti-abuse rules in particular situations, such as treatment of NOLs (and current year losses), distinction between deduction for royalties and exclusion of COGS including an intangible element, no allowance for netting or lookthru to unrelated party payments, and distinctions between various structures (e.g., use of a foreign subsidiary rather than U.S. subsidiary to purchase equipment, machinery and intangibles from related parties and sell into the U.S.) 29

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