On September 3, the Department of the Treasury issued final regulations regarding the base erosion and antiabuse tax ("BEAT") imposed on certain large corporate taxpayers with respect to certain payments made to foreign related parties.1 The final regulations provide guidance on a number of areas, an important section of the regulations pertains to the election to waive deductions for purposes of the BEAT. In this article, we will outline the reasons for, and the mechanics of, this election, as well as how this election, while a taxpayer-friendly inclusion in the regulations, can come at a significant cost for taxpayers. Additionally, the final regulations contained a relaxed anti-abuse provision that makes the effects of the anti-abuse provision less dramatic.
The Election to Waive Deductions for Purposes of BEAT
Overview of the Election
The BEAT serves as a minimum tax on payments to foreign related parties: 5% for 2018, 10% for 2019-2025, and 12.5% thereafter.2 The tax applies to "applicable taxpayers," defined as corporations (other than regulated investment companies, real estate investment trusts, or S corporations) with at least $500 million average annual gross receipts over the previous three taxable years and whose "base erosion percentage" is 3% or higher.3 The "base erosion percentage" is calculated by dividing the corporation's "base erosion tax benefits" (generally, deductions resulting from amounts paid to foreign related parties) by the corporation's aggregate deductions for the taxable year, less certain excluded items.4 Since the BEAT was introduced, practitioners have feared a "cliff" effect, as, when determining a taxpayer's base erosion percentage, $1 of deductions resulting from amounts paid to foreign related parties could be the difference between a taxpayer being subject to a significant BEAT liability or not being subject to BEAT at all.5
To address this concern, the Department of the Treasury included in its proposed BEAT regulations issued December 2, 20196 an election allowing taxpayers to waive deductions for the purposes of BEAT, and has maintained this election in the final regulations.7 By making this election, taxpayers who may be applicable taxpayers under BEAT may waive deductions that they would otherwise be able to claim in order to reduce their base erosion percentage, and thus avoid application of, and liability under, BEAT.8
Drawbacks of the Election
However, while this election is a taxpayer-friendly solution allowing taxpayers to avoid the BEAT "cliff", it comes with a pair of potentially significant drawbacks.
The first drawback is the basic mechanism by which the election allows taxpayers to avoid BEAT liability: waiver of deductions they would otherwise be able to claim. For large companies, who may routinely have hundreds of millions, or even billions, of dollars in deductions every year, waiving even 1% of their deductions would amount to losing millions of dollars. While this sacrifice may be well worth avoiding a much larger liability under BEAT, it remains a hefty cost.
The second drawback is that taxpayers have no recourse if they inadvertently elect to waive more deductions than are necessary to avoid BEAT. When the Department of the Treasury issued the proposed regulations, these regulations provided taxpayers the flexibility to make or to increase a BEAT waiver election on an amended Federal income tax return or during the course of an examination of the taxpayer's income tax return.9 However, the proposed regulations did not allow a taxpayer to decrease the amount of deductions waived under the BEAT waiver election or revoke that election on any amended Federal income tax return or during an examination.10 While the Department of the Treasury received a number of comments requesting that the final regulations permit taxpayers to decrease the amount of waived deductions, it did not adopt these comments in the final regulations. 11 Because of this, a taxpayer close to the "cliff" cannot revoke an election that turned out not to be necessary, and a taxpayer that inadvertently waives more deductions than necessary will lose out on these deductions.
Relaxed Anti-Abuse Provision
The BEAT's anti-abuse provision12 relates to the fact that certain non-recognized transactions are exempted from the calculation of BEAT payments. For the purposes of BEAT, certain reorganization transactions are not recognized where a U.S. subsidiary receives property in exchange for stock or securities.13 However, the anti-abuse provision provides that a transaction is not exempted if the "principle purpose" of the transaction was to increase adjusted basis, in order to avoid the BEAT.14 Under the 2019 final regulations, the anti-abuse provision contained an irrebuttable presumption that it was triggered if a transaction increased the adjusted basis six months prior to the taxpayer's acquisition of the property.15 The new final regulations retain this presumption, but have revised the anti-abuse provision to clarify that the transaction 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 non-recognition transaction in order to trigger the provision. 16 In addition, the new final regulations have made the effect of the provision less significant: while the anti-abuse provision previously included the property's entire basis in the BEAT payment calculation, the anti-abuse provision now only includes the stepped-up basis amount in the BEAT payment calculation.17
In considering the implications of the BEAT, taxpayers should carefully consider whether it is necessary to waive any deductions in order to avoid being subjected to the BEAT. In considering when to waive deductions, taxpayers should be aware that deductions can be waived for the first time either on an initial return or on an amended return. If waiving deductions, taxpayers should keep in mind that the final regulations provide an opportunity to subsequently increase the amount of waived deductions on an amended Federal income tax return or during the course of an examination of the taxpayer's income tax return, but there is no future opportunity to decrease the amount of deductions waived.
1. T.D. 9910; RIN: 1545-BP36 (9/1/2020).
2. 26 U.S.C. § 59A(b).
3. 26 U.S.C. § 59A(e).
4. 26 U.S.C. § 59A(c), (d).
5. See, e.g., "Final BEAT Waiver Regs Reach OIRA", Andrew Velarde, Tax Notes Today 8/6/2020.
7. T.D. 9910, Part III.
9. See Proposed §1.59A-3(c)(6)(iii).
10. See Id.
11. See T.D. 9910, Part III(C).
12. Reg. §1.59A-9(b)(4).
13. See Reg. §1.59A-3(b)(3)(viii).
14. Reg. §1.59A-9(b)(4).
15. TD 9885; RIN: 1545-BO56 (12/6/2019), §1.59A-9(b)(4).
16. T.D. 9910, Part V; Reg. §1.59A-9(b)(4).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.