The BEAT—the base erosion and anti-abuse tax—is another one of the tax reform “sticks” created by the Tax Cuts and Jobs Act (P.L. 115-97, hereinafter “TCJA” or “tax reform”). This particular stick was created with the express purpose of leveling the playing field between U.S.-headquartered companies and foreign-headquartered companies, a goal that its drafters hope will be achieved by curtailing the U.S. tax benefit of cross-border payments made by large multinationals. Indeed, the BEAT is estimated to raise almost $150 billion over a 10-year period, and is a marquee piece of Tax Reform. As of the date of publication, the Treasury Department has not issued BEAT regulations, so for the time being we only have the plain language of tax code Section 59A as well as the legislative history to serve as our guideposts. Nonetheless, given its significance, multinational groups have been struggling to evaluate and address BEAT risks since its initial proposal.
As with the other articles in this “Fundamentals of Tax Reform” series, this piece is intended only to provide a general overview of the BEAT rules contained in new Section 59A, and insight into some of the more commons issues and questions that practitioners are encountering. Accordingly, this article goes through a basic discussion of the BEAT operating rules, as well as a few practical notes—the nuances and resolutions to which may very well change as guidance is issued and evolves.
With Tax Reform, Congress repealed the corporate alternative minimum tax (AMT), eliminating at least some of the complexity inherent in U.S. corporate taxation—only to replace it with the BEAT, a new (albeit narrower) brand of minimum tax that features many of its own complexities. While, as with so much of Tax Reform, a solid understanding of BEAT requires a lengthy vocabulary list of jargon and acronyms, as well as a careful walk-through of several calculations, it is helpful to keep in mind its role as a minimum tax, and to remember that it targets base erosion payments. That is, BEAT can be thought of as protecting the U.S. federal income tax base from an “inappropriate” level of base stripping, by imposing a partial clawback of certain deductions associated with payments to related parties, as well as other costs intended to disincentivize outbound payments. While the underlying deduction remains intact, BEAT imposes an addition to tax—first at a 5 percent rate for taxable years beginning with calendar year 2018, increasing to 10 percent for 2019-2025, and topping out at 12.5 percent thereafter. (Banks and registered securities dealers are hit with a BEAT rate that is 1 percent higher every year.)
Significantly, BEAT has only little to do with the transfer pricing rules. Although the two regimes focus on intercompany payments, arm’s length pricing will not excuse a payment from BEAT (and, correlatively, non-arm’s length pricing won’t itself trigger BEAT). If anything, taxpayers might think of transfer pricing as applying first, to determine the magnitude of the valid deduction, then BEAT as applying to determine whether additional tax is owed in relation to the deduction.
At the same time, the new BEAT rules include explicit and implicit significant exceptions. First, the taxpayer must be big enough to warrant application of the rules (an “Applicable Taxpayer”). Next, the taxpayer’s tainted deductions must exceed a specified threshold, when viewed as a percentage of the Applicable Taxpayer’s total deductions (3 percent generally). Finally, certain low-margin (e.g., back office) payments, qualifying derivatives payments, and payments qualifying as “costs of goods sold” are excepted from the scope of tainted base erosion payments.
Let’s take the analysis in steps.
1. Who qualifies as an “applicable taxpayer”?
As a general matter, the BEAT only applies to C corporations. Individuals, partnerships, and certain corporations that are taxed on a flow-through basis—regulated investment companies, real estate investment trusts, and S corporations—are not subject to this new minimum tax. In addition to regular C corporation status, two other conditions, discussed below, must be met to trigger the BEAT rules:
- Gross receipts test. The taxpayer must have average annual domestic gross receipts for the prior (rolling) 3-year period of at least $500 million, and
- BE% test. The taxpayer’s “base erosion percentage” for the tested year is at least 3 percent.
a. Gross Receipts Test
From the perspective of a standalone entity, $500 million in gross receipts sounds like a lot. However, the BEAT rules contain an aggregation provision that views all corporations that are members of the same “controlled group”—using Sections 52 and 1563 to scope the group—as a single corporation. This brings corporations that are at least 50 percent (vote or value) directly, indirectly or constructively related, together for purposes of this test.
Significantly, the BEAT rules include foreign corporations in a controlled group, but for purposes of the gross receipts test, a foreign corporation’s gross receipts are only taken into account to the extent they are effectively connected with the conduct of a U.S. trade or business (ECI).
As significantly, keep in mind that the aggregation rule applies for purposes of determining whether the members of the group (as a whole) are subject to the BEAT rules (individually). Consider the following structure, pictured below: Japanese Parent (JP), owns stock of three U.S. corporations, two of which, in turn, are parents of U.S. consolidated groups. The JP group also includes several foreign subsidiaries. However, of the foreign corporations within the group, only JP maintains a U.S. branch, through which it earns ECI.
In the diagram below, all corporations that are at least 50 percent owned by JP are within the testing group. From there, JP must identify all in-scope gross receipts, i.e., the gross receipts of all of the controlled U.S. entities as well as U.S. ECI. In keeping with the single corporation principle, intercompany transactions within a single U.S. consolidated group, as well as transactions among the U.S. consolidated groups, the standalone U.S. corporation, and the U.S. branch, are eliminated.
If the BEAT rules are found to apply to the JP group, the BEAT liability of each U.S. “taxpayer” is assessed on a standalone basis. Subject to further guidance, it appears that US Parent #1 (and its consolidated group member) is treated as a separate taxpayer, with a separate potential BEAT liability, from US Parent #2, US Parent #3 (and its consolidated group member), and US ECI branch.
Practical Notes: Remember that, although the gross receipts test does not literally include the gross receipts of U.S. or foreign partnerships, U.S. corporate partners should take into account their gross receipts earned through partnerships, and foreign corporate partners should include their shares of a partnership’s U.S. effectively connected taxable income.
b. BE% Test
As discussed above, the BEAT imposes a minimum tax on outbound, related party payments that have the effect of “inappropriately” reducing the U.S. federal income tax base. While a certain amount (and, as described below, a certain type) of base erosion is treated as acceptable, too much of a good thing is not a good thing. At base, this is a test of whether deductions attributable to tainted payments (i.e., those that are made to related foreign parties, that are not otherwise eligible for an exception) exceed 3 percent of “all” of the deductions reflected on the taxpayer’s tax return. The threshold is dropped to 2 percent for banks and securities dealers. The base erosion percentage is determined on an aggregate basis using the aggregation rules described above.
If the taxpayer exceeds the applicable threshold, it is subject to potential BEAT liability. (In that case, keep this BE% calculation handy for later.)
The Denominator: Allowable Deductions
Let’s start with the easiest part of the calculation, the denominator. The denominator has a promising start—“all” of the taxpayer’s allowable deductions for the year—but then takes an unhelpful turn, by reducing this amount by net operating losses (NOLs), the new Section 250 deduction (related to “Foreign Derived Intangible Income” and “Global Intangible Low Taxed Income”), and the new dividend-received deduction of Section 245A. Any deductions for payments that are excepted from the definition of “base erosion payments” (and, consequently, are removed from the numerator) are also excluded from the denominator.
The Numerator: Base Erosion Tax Benefits
The numerator is the universe of tainted deductions, i.e., “base erosion tax benefits.” Generally speaking, these are any tax benefits arising from certain amounts paid or accrued by a taxpayer to a related foreign person, with respect to base erosion payments. This includes base erosion payments arising from deductions allocable to a U.S. branch, although there is an open question of whether these include “payments” or remittances between the U.S. branch and its foreign home office.
“Related” is, for these purposes, a very broad term, and generally includes:
1. Any 25 percent owner of the taxpayer (by vote or value);
2. Entities that are related, based on a greater than 50 percent ownership (direct, indirect, and constructive) to either the taxpayer or to a 25 percent owner of the taxpayer; and
3. Any persons related under the Section 482 transfer pricing rules, which can include parties not actually or constructively related, but who are acting in concert with one another.
The BEAT rules cross reference Section 6038A(c)(3), for the meaning of “foreign person,” which is broadly defined as any person who is not a “United States person.” A United States person includes a citizen or resident of the U.S., a domestic partnership, a domestic corporation, and any estate other than a foreign estate. Trusts may also qualify as United States persons if a court within the U.S. is able to exercise primary supervision over the administration of the trust, and one or more U.S. persons have the authority to control all substantial decisions of the trust.
Practical Notes: In most cases,determining whether payments are being made to a U.S. or foreign person is not difficult, but what about U.S. partnerships owned by foreign persons, and vice versa? Does the BEAT catch payments made to a U.S. partnership with all foreign corporate partners? What about payments toa foreign partnership with all U.S. corporate partners?Or payments by partnerships to their partners? Under a literal reading of the BEAT rules, it would appear that payments made to a foreign partnership with U.S. partners are potentially “BEAT-able” while payments made to a U.S. partnership with foreign partners arenot. One could, however, reasonably see all deductions and payments flowing from the partnership through to the partners;in that case,the BEAT consequences would be assessed at the partner level with an eye to partnership level facts (e.g., for determining whether a payment is for an service cost method (SCM)-eligible activity). One could also reasonably see guaranteed payments to a foreign partner being subject to BEAT. Until guidance is released, taxpayers should model and understand the risks arising from all potential partnership payments, and plan accordingly.
After identifying deductible payments made to related foreign persons, the taxpayer’s next task is to ferret out the ones that constitute base erosion payments. There are four types:
(i) Deductible payments made to a related foreign person. This does not include any interest expense that is disallowed under Section 163(j) (as modified by the TCJA), though disallowed interest is treated as coming first from payments to unrelated lenders.
(ii) Payments to a related foreign person, in connection with the acquisition of amortizable or depreciable property. Only the amount of amortization or depreciation that gives rise to deductions during the year is taken into account as a base erosion tax benefit.
(iii) Reinsurance premiums or other consideration paid to a related foreign person.
(iv) Payments to members of an inverted group, that result in a reduction of the taxpayer’s gross receipts. This means that payments that are otherwise included in COGS (and subject to the implicit exception described below) are, in the inverted group scenario, pulled back within the scope of the BEAT rules.
If a base erosion payment also contributes to a taxpayer’s NOL, the taxpayer gets a double hit of base erosion tax benefits – the underlying deduction for the payment, as well as a portion of the deduction when the NOL is later deducted against income.
Practical Notes: Double check the amount of the outbound payments that flow through the base erosion payments calculation. For example, Treasury Regulation Section 1.482-7 permits some netting of amounts paid by a U.S. cost sharing participant against certain amounts received by foreign cost sharing participants, in a qualified arrangement. Be careful to “net within bounds.” As we read them, and absent further guidance, the regulations permit U.S. deductions to be reduced by cost sharing payments received on a pro rata basis, i.e., inbound payments will also proportionately reduce deductions that would not otherwise be subject to BEAT.
While the term “base erosion payment” is very broad in scope, it isn’t limitless. A few types of payments are explicitly excluded from the term.
Payments for SCM-eligible services. First, Section 59A excludes any amount paid or incurred for foreign services that meet certain requirements for services cost method (SCM) treatment, under Treas. Reg. Section 1.482-9 (SCM regulations). Several requirements must be satisfied with respect to the service being performed in order to be eligible for SCM treatment, and while a detailed discussion of these rules is beyond the scope of this article, they can generally be summarized as follows:
(i) The underlying service must qualify as a “covered service.” Qualifying activities generally include a service transaction (or group of service transactions) that are either on an “angel” list issued by the Internal Revenue Service, or are “low margin services.” Angel list services are common, low value support services—e.g., payroll, human resources, IT support—that typically do not involve a significant markup. The IRS published an angel list of 101 activities in Revenue Procedure 2007-13. Treas. Reg. Section 1.482-9 (b)(5) provides that, for the service to be treated as a covered service, the taxpayer must reasonably conclude in its business judgment that the service “does not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure” of the controlled group’s business (known as the “business judgment rule”). Fortunately, the BEAT rules turn off the business judgment rule when determining whether payments are base erosion payments. Consequently, and subject to further guidance on this point, a taxpayer does not need to exclude IT support services even if, for example, logistics software is a critical driver of the taxpayer’s business.
“Low margin” services are controlled services transactions that are neither included in the angel list, nor are explicitly excluded from SCM treatment, provided that the median transfer price of market comparable services includes a mark-up of 7 percent or less.
(ii) The underlying service must not be one of the activities excluded by Treas. Reg. Section 1.482-9 (b)(4). These “black listed” activities include, among other things, manufacturing, production, construction, reselling or distribution, research and development, and engineering or scientific activities.
(iii) The taxpayer must maintain adequate books and records. In general, the books and records must be adequate to permit verification by the IRS of the total services costs incurred by the renderer, including a description of the services in question, identification of the renderer and the recipient of such services, and sufficient documentation to allow verification of the methods used to allocate and apportion such costs to the services in question. (The SCM regulations also require a statement declaring the taxpayer’s intention to apply the SCM rules for purposes of determining arm’s length pricing. Presumably, because the BEAT rules expand the scope of the exception beyond activities that would qualify to use the SCM—i.e., by turning off the business judgment rule—this statement is not required.)
Practical Notes: Notwithstanding that the SCM regulations permit eligible payments to be compensated at cost, payments are often priced at cost plus a mark-up in order to satisfy the transfer pricing regulations in the foreign recipient’s jurisdiction. In such cases, there is a question as to whether the SCM exception is available for the cost component of the payment for services, even where a mark-up is also paid. This arises because the statutory language for SCM exception requires that “such amount [must constitute] the total services cost with no markup component.” The question is whether the language limits the amount of the payment to which the exception applies, or availability of the exception as a whole. Pending further guidance, the authors believe that, despite payment of a markup, it is reasonable to conclude that the SCM exception applies to the cost component of an otherwise qualifying payment. Note, however, if the taxpayer in fact elects SCM treatment for transfer pricing purposes, any actual mark-up paid appears to be a nondeductible corporate distribution, e.g., a dividend.
Qualified Derivatives Payments. Pursuant to Section 59A(h), qualified derivative payments are also excluded from the definition of “base erosion payment.” In very general terms, a derivative is any contract the value of which is determined by the performance of an underlying asset, such as stocks, bonds, commodities, or currency. For BEAT purposes, a “qualified derivative payment” means payments made by a taxpayer pursuant to derivatives contracts that are annually marked-to-market and on which the taxpayer annually recognizes ordinary gain or loss.
Cost of Goods Sold (COGS). Payments that constitute COGS are also excepted from the definition of base erosion payments. This exception is a little less obvious than the others. It was first heralded by the BEAT’s legislative history, which notes that base erosion payments do not include reductions to gross receipts, including COGS, as opposed to deductions. The exception becomes a little more obvious in the “negative space” around an add-back to base erosion payments. That is, Section 59A(d)(4) brings payments that reduce gross receipts back into the scope of base erosion payments, when such payments are made to related parties within an inverted group. Taken together with the legislative history, this add-back spells a significant source of relief from BEAT risk.
Given that Section 59A does not include an explicit COGS exception, it is perhaps not surprising that it provides no special guidelines as to the scope or meaning of “cost of goods sold.” Subject to more specific guidance for the BEAT context, taxpayers are left with authorities under, and related to, Sections 471 and 263A. For a more detailed discussion of the COGS rules, particularly their implications for a BEAT analysis, see A COGS Primer for BEATniks, 47 TMIJ 367 (2018).
Practical Notes: Perhaps the most significant, gating consideration is whether the taxpayer is engaged in sales transactions. That is, while cost of goods sold have the effect of reducing gross receipts from sales transactions, there is no such reduction in the non-sales context. Costs related to services, leases, licenses, and other non-sales transactions are generally taken as deductions, and therefore remain potentially subject to BEAT (unless they qualify for another exception).
Another open issue is whether, if an analysis of deductions reveals costs that should have instead been included in COGS, a taxpayer should file an IRS Form 3115, and apply to the IRS for a change in method of accounting. Arguably, if the cost is not allocated to ending inventory, there is no timing difference between treating it as a deduction versus treating it as COGS. On balance, however, and subject to further guidance, we believe the change in classification—that could otherwise affect timing of recovery—merits treatment as a method change.Finally, think about the trickle down effects of reclassifying one set of costs as COGS. For example, just because COGS treatment has a BEAT benefit and doesn’t present timing differencesfor some costs does not mean the same is true across the board. An exam agent will not necessarily limit his or her focus to the reclassified items. Be sure thatyou can live with the consequences of COGS treatment being applied to similar costs that do not pose a BEAT risk.
Payments Subject to Withholding. Section 59A (c)(2)(B) excludes base erosion payments that qualify as fixed or determinable annual or periodical (FDAP) income and are subject to withholding at the statutory 30 percent rate. The term “FDAP income” generally includes all types of gross income earned by a foreign person from a US source, as long as the income is not effectively connected with the conduct of a trade or business in the U.S., or is otherwise excepted from the definition. Examples include royalties, rents, license fees, and commissions and other income related to services. If withholding is reduced, e.g., under an applicable treaty, only a proportionate (taxable) share of the payment is excluded from the BEAT rules.
2. Calculating BEAT Additions to Tax
Taxpayers identifying a BEAT issue for themselves very quickly turn to calculating their potential liability. Because BEAT is a minimum tax, the taxpayer will need to calculate its minimum tax burden then compare this amount against its regular federal income tax liability; any excess BEAT liability is the addition to tax. This is relatively straightforward in concept, but less so in practice.
a. The Benchmark (Minimum) BEAT Liability
As noted above, the applicable BEAT rate starts at 5 percent beginning with calendar year 2018, then ratchets up to 10 percent after that first year, and jumps again in 2026, to 12.5 percent. This sounds pretty good as a benchmark, except that the tax base against which it is assessed—modified taxable income or “MTI”—is significantly expanded when compared with the norm.
The MTI starting point is the taxpayer’s taxable income, calculated under the general tax rules. MTI is then effectively increased by the amount of the taxpayer’s base erosion tax benefits. (That’s the same BETB amount used as the numerator in the BE% calculation above.) In addition, the portion of the NOL deemed attributable to BETBs gets added back; that is found by multiplying NOLs absorbed for the year (if any), against the BE% calculated above. These add-backs are, effectively, BEAT’s partial clawback mechanism.
Note, to the extent any amount of a BEAT payment was excluded from the taxpayer’s BETBs, it should likewise be excluded from MTI.
Practical Notes: Section 59A defines MTI as the taxable income of the taxpayer “without regard to” base erosion tax benefits or the BE% of any NOL deduction (NOL BE%) allowed for the year. It is unclear from the language of the statute whether this phrase—“without regard to”—is intended to require taxpayers to simply add back their base erosion tax benefits and the NOL BE% to taxable income, or whether Congress intended that taxpayers recalculate taxable income without the benefit of their BETBs or the BE% of their NOL deduction. For some taxpayers, the difference in the results between these two methods could end up being quite significant.
The statute is also silent on whether and how BEAT applies with respect to NOLs generated prior to Tax Reform. For example, assuming that pre-Tax Reform NOLs are subject to BEAT in the year in which they are absorbed (and not, instead, grandfathered from BEAT entirely), Section 59A does not specify whether the taxpayer should apply the base erosion percentage from the NOL origination year or from the absorption year—and if the former, how a base erosion percentage should be calculated for an entirely pre-Tax Reform, pre-BEAT period. The authors don’t believe it is likely that pre-Tax Reform NOLs will be excused from BEAT, so taxpayers should be modeling BEAT exposure under a hypothetical, pre-Tax Reform BE% calculation, as well as an absorption year calculation. In addition, because deductions giving rise to NOLs result in a “double BEAT hit,” those payment streams should be prioritized in taxpayers’ BEAT mitigation planning.
b. Taxes Treated as ‘Paid’
Next, the taxpayer must compute the amount of taxes it is treated as having paid for BEAT purposes. This starts with an application of the 21 percent corporate tax rate, against the taxpayer’s normal taxable income (i.e., including the full benefit of deductions otherwise treated as BETBs), referred to as the taxpayer’s “regular tax liability.”
As we know, however, that’s very rarely the end of the story, as most taxpayers will have the benefit of a range of credits. However, the benefit of the credits is significantly limited for BEAT purposes.
The statutory construct is a little confusing here: The taxpayer’s regular tax liability is reduced (but not below zero) by the excess (if any) of (i) credits allowed against such liability, over (ii) the sum of research and experimentation (R&E) credits plus a portion of other applicable Section 38 credits (including the low-income housing credit, renewable energy production credit, and energy credits) allowed for that year. The Section 38 credit amount is capped—up to 80 percent of the lesser of such credits or of the base erosion minimum tax (i.e., the benchmark BEAT liability calculated above).
Let’s deconstruct this a little bit. First, the bottom line is that the taxpayer’s regular tax liability must be reduced by credits; the taxpayer does not get the benefit of “paying” tax liability it has satisfied via credits. (Remember that bigger is better here, because it’s the delta between regular tax liability and the benchmark (minimum) BEAT liability that is the addition to tax.)
For now, only a portion of the credits reduces regular tax liability. That portion does not include—meaning, the taxpayer is effectively treated as if it paid regular tax liability satisfied by—R&E credits, or the result of the 80 percent comparison above. Once 2026 hits, however, all credits reduce the regular tax liability (i.e., the taxpayer loses the benefit of all credits for purposes of the BEAT).
BEAT Calculation Example
Let’s walk through a basic example, using a simplified version of the JP group. Recall that JP owns separate chains of US subsidiaries. We will assume that the JP group satisfies the gross receipts and BE% tests, so that its payments are potentially subject to BEAT. Let’s also assume that the JP group is not inverted.
Pictured below is US Parent #1, which purchases components and works-in-progress from JP, then on-sells within its U.S. consolidated group, to US Sub. JP extends an operating loan to US Parent #1, who pays arm’s length interest. US Sub licenses IP from Foreign Sub, which is used in the production of final products, as well as a fee for marketing services. Ultimately, the US Sub transfers final products to its customers; for now, let’s assume that all of these transfers qualify as sales for U.S. federal income tax purposes.
Now let’s add some simple numbers into the mix. US Parent #1 purchases components from JP for $180 and on-sells at cost, to US Sub. US Parent #1 makes a $150 interest payment to JP. US Sub pays a $20 royalty to Foreign Sub for the use of its production IP, and $300 for marketing services. Neither JP nor Foreign Sub pays any U.S. withholding tax on these amounts. The US Parent #1 group has another $50 of local operating expenses, and takes a $10 Section 46 investment credit, as well as a $15 R&E credit; there are no Section 38 credits. US Sub earns $1,000 of gross income from its sales. For purposes of this example, we will ignore any potential application of Section 163(j) or other, non-BEAT rules, and will assume that none of the costs are hung up in US Sub’s ending inventory.
Here is US Parent #1’s (really, it’s the group’s) BEAT liability calculation:
Now let’s tweak the facts a little bit, to show how business changes can have multidimensional effects on a taxpayer’s tax analysis. We will stay in the same year, so that the BEAT rate remains 10 percent and the group retains the benefit of the R&E credits. But now let’s assume that instead of selling all of the final products, US Sub only sells 50 percent of them; the other 50 percent are leased to customers. This means that, assuming the costs of production are evenly spread among all products, only 50 percent of the purchases and royalties are eligible for COGS treatment. The leased products (let’s say equipment) sit on the U.S. consolidated group’s balance sheet, and as they depreciate will generate additional base erosion payments. To make things easier, let’s assume depreciation of $18 in this period. Because we have shifted 50 percent of the purchase payments from immediate recovery as COGS, to a slower depreciation recovery, JP’s normal U.S. tax liability increases. Remember, we are assuming that recasting the royalties as deductions results in no timing difference, so the depreciation is the only change on the “normal” side while, on the BEAT side, modified taxable income increases by both amounts. The U.S. group owes less BEAT tax in this scenario, but with the increased burden on the regular corporate tax side, it pays more taxes on an overall basis.
Finally, let’s go back to the base case and tweak the facts a little differently, by fast forwarding to 2026. The passage of time alone creates two additional problems—the applicable BEAT rate jumps from 10 percent to 12.5 percent, and JP loses the benefit of R&E credits in the BETMA calculation. This changes the calculation in the following ways:
The bottom line here is that the JP group really cannot afford to sit on its BEAT problem.
This is a good time to note that Section 59A authorizes regulations geared toward ensuring that taxpayers’ “BEAT management” does not get out of hand. In particular, Section 59A(i) authorizes the Secretary to draft anti-abuse provisions which may further curb taxpayers’ ability to effectively manage their BEAT issues. And remember, if regulations are issued before June 22, 2019, Section 7805(b) provides for retroactive effect, back to the date of the statute’s enactment.
3. Reporting and penalties
In addition to creating the BEAT rules, Tax Reform also revised Section 6038A, which requires new, BEAT-specific information reporting. As of the date of this article, the IRS has issued a draft Form 8991 (see https://www.irs.gov/pub/irs-dft/f8991—dft.pdf), which would require taxpayers to demonstrate their gating, Applicable Taxpayer calculations, as well as calculations related to the computation of BEAT liability (if any). Note, taxpayers will want to tie their BEAT-related COGS reporting to the amounts normally reported as COGS, on Form 1125-A.
Consideration should also be given to customs declarations with respect to imported materials, components, and goods, as Section 1059A links COGS reported and used for tax purposes, with COGS used as the basis for customs valuation. Significantly, customs issues also come with recent increases in tariff rates, stiff potential penalties for underreported value, and a 5-year statute of limitations. See Tax Reform May Be the Epicenter, But Be Wary of Trade and Customs Aftershocks, 47 TMIJ 163 (2018) for a more detailed discussion on Tax Reform and U.S. trade and customs issues.
Finally, although an updated version of Form 5472 and the related instructions were released as recently as December 2017, they may need to be revised again, to accommodate the BEAT reporting provisions. To ensure focus on the new requirements, Congress also increased the penalties related to Form 5472 from $10,000 per form to $25,000. Regardless, taxpayers would be smart to reconcile their BEAT payments with any intercompany payments reported on the Form 5472, as well as related party, withholdable payments reported on Forms 1042-S. Given the relief provided for payments subject to U.S. withholding, now would also be a good time to confirm that foreign payees’ Forms W-8 (BEN-E, etc.) are in order.
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BEAT is a Tax Reform stick that is just too big for taxpayers to ignore. Many affected taxpayers have been frantically modeling their various base case and “future state” BEAT scenarios, and we expect this exercise to continue for some time. The modeling exercise only increases in complexity once other aspects of Tax Reform are layered in, as they must be. BEAT, the FDII and GILTI rules, revised Section 163(j)—all are interrelated, with added levels of difficultly for taxpayers with NOLs or significant credits.
The services sector, left out of the COGS exception, is particularly hard hit by BEAT, and many companies are facing some difficult supply chain choices in the near future. Nor does the manufacturing sector escape entirely unscathed, as benefits from the COGS exception could result in significant, possibly overwhelming, “givebacks” in terms of increased tariff costs for imported goods and materials. One way or another, solving a BEAT problem can be a painful process and may involve significant operational changes.
Need a place to start with your BEAT planning? Consider the following:
- Is it a realistic option to restructure the payment flows? For example, instead of having a U.S. entity sign a global services agreement and subcontract to foreign affiliates, could the foreign or even U.S. pieces of the contract be taken on overseas, eliminating outbound services payments?
- What outbound services payments could qualify for the SCM exception? Can large payments be unbundled, and SCM-eligible components clearly broken out from BEAT-able payments? Are your books and records sufficient to support the added pressure of a BEAT-specific audit?
- Are there payments that are currently being deducted, that should instead be treated as COGS? If so, don’t forget the other potential knock-on effects (trade and customs impact, potential accounting method changes).
- Is there any ability to net outbound payments with inbound payments from the same related foreign person? The qualified cost sharing regulations permit limited netting; the same may or may not be true with respect to other reciprocal payments.
As time goes on, more BEAT coping strategies will undoubtedly emerge, and will also undoubtedly evolve as more BEAT guidance is issued. Stay tuned.
Kimberly Majure is a principal with the international tax group of the Washington National Tax practice of KPMG LLP and also serves as the inbound tax services lead for KPMG U.S.; she is based in the firm’s Washington, D.C. office. John is a managing director with the international tax group of the Washington National Tax practice of KPMG LLP and is based in the firm’s Washington, D.C. office.
The authors would like to thank Michael H. Plowgian, KPMG LLP, for his insightful comments and suggestions, and Juan Sanchez, our invaluable Georgetown LLM extern, for his contributions.