[Federal Register Volume 84, Number 235 (Friday, December 6, 2019)]
[Rules and Regulations]
[Pages 66968-67045]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-25744]
[[Page 66967]]
Vol. 84
Friday,
No. 235
December 6, 2019
Part II
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Base Erosion and Anti-Abuse Tax and Additional Rules Regarding Base
Erosion and Anti-Abuse Tax; Final Rule and Proposed Rule
Federal Register / Vol. 84 , No. 235 / Friday, December 6, 2019 /
Rules and Regulations
[[Page 66968]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9885]
RIN 1545-BO56
Base Erosion and Anti-Abuse Tax
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations implementing the base
erosion and anti-abuse tax, designed to prevent the reduction of tax
liability by certain large corporate taxpayers through certain payments
made to foreign related parties and certain tax credits. These final
regulations also provide reporting requirements related to this tax.
This tax was added to the Internal Revenue Code (the ``Code'') as part
of the Tax Cuts and Jobs Act. This document finalizes the proposed
regulations published on December 21, 2018. The final regulations
affect corporations with substantial gross receipts that make payments
to foreign related parties. The final regulations also affect any
reporting corporations required to furnish information relating to
certain related-party transactions and information relating to a trade
or business conducted within the United States by a foreign
corporation.
DATES: Effective date: The final regulations are effective on December
6, 2019. Applicability dates: For dates of applicability, see
Sec. Sec. 1.59A-10, 1.1502-2(d), 1.1502-59A(h), and 1.6038A-2(g).
FOR FURTHER INFORMATION CONTACT: Concerning Sec. Sec. 1.59A-1 through
1.59A-10, Azeka J. Abramoff, Sheila Ramaswamy, or Karen Walny at (202)
317-6938; concerning the services cost method exception, L. Ulysses
Chatman at (202) 317-6939; concerning Sec. Sec. 1.383-1, 1.1502-2,
1.1502-4, 1.1502-43, 1.1502-47, 1.1502-59A, 1.1502-100, and 1.6655-5,
Julie Wang at (202) 317-6975 or John P. Stemwedel at (202) 317-5024;
concerning Sec. Sec. 1.6038A-1, 1.6038A-2, and 1.6038A-4, Brad
McCormack or Anand Desai at (202) 317-6939 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
On December 21, 2018, the Department of the Treasury (``Treasury
Department'') and the IRS published proposed regulations (REG-104259-
18) under section 59A, and proposed amendments to 26 CFR part 1 under
sections 383, 1502, 6038A, and 6655 in the Federal Register (83 FR
65956) (the ``proposed regulations''). The base erosion and anti-abuse
tax (``BEAT'') in section 59A was added to the Code by the Tax Cuts and
Jobs Act, Public Law 115-97 (2017) (the ``Act''), which was enacted on
December 22, 2017. The Act also added reporting obligations regarding
this tax for 25-percent foreign-owned corporations subject to section
6038A and foreign corporations subject to section 6038C.
A public hearing was held on March 25, 2019. The Treasury
Department and the IRS also received written comments with respect to
the proposed regulations. Comments outside the scope of this rulemaking
are generally not addressed but may be considered in connection with
future guidance projects. All written comments received in response to
the proposed regulations are available at www.regulations.gov or upon
request.
Summary of Comments and Explanation of Revisions
I. Overview
The final regulations retain the basic approach and structure of
the proposed regulations, with certain revisions. This Summary of
Comments and Explanation of Revisions discusses those revisions as well
as comments received in response to the solicitation of comments in the
notice of proposed rulemaking accompanying the proposed regulations.
II. Comments and Changes to Proposed Sec. 1.59A-1--Overview and
Definitions
Proposed Sec. 1.59A-1 provides general definitions under section
59A. Proposed Sec. 1.59A-1(b)(17) provides a definition of the term
``related party.'' The proposed regulations generally define a related
party with respect to an applicable taxpayer as (a) any 25-percent
owner of the taxpayer, (b) any person related (within the meaning of
section 267(b) or 707(b)(1)) to the taxpayer or any 25-percent owner of
the taxpayer, or (c) a controlled taxpayer within the meaning of Sec.
1.482-1(i)(5).
The proposed regulations' definition of ``related party'' is
identical to the definition provided by section 59A(g), except with
respect to the relatedness standard under section 482. Specifically,
the proposed regulations provide a more precise citation to the section
482 regulations (``a controlled taxpayer within the meaning of Sec.
1.482-1(i)(5)'') than the general cross-reference that is provided in
section 59A(g)(1)(C) (``any other person who is related (within the
meaning of section 482) to the taxpayer'').
Comments recommended that the final regulations modify the
definition of ``related party'' to exclude related publicly traded
companies or otherwise provide an exception for payments between
publicly traded companies. These comments suggested that payments
between related publicly traded companies do not result in base
erosion. The comments explained that the boards of directors of
publicly traded companies generally have fiduciary obligations to
shareholders to act in the best interest of the company and are subject
to regulatory oversight. On this basis, the comments asserted that a
domestic corporation cannot artificially shift profits to a foreign
corporation in this situation. Comments also noted that the Treasury
Department and the IRS have provided relief for publicly traded
companies in circumstances where there is no explicit legislative
history or statutory authority to do so, such as where minority
shareholders of publicly traded companies must be identified. See Sec.
1.367(e)-1(d)(3) and Sec. 1.382-2T(j).
The Treasury Department and the IRS have determined that it is not
appropriate to modify the statutory definition of a related party to
exclude publicly traded companies because this recommendation is
inconsistent with the statutory language of section 59A(g). Section
59A(g) sets forth specific limits on the definition of a ``related
party'' that include a corporation and its 25-percent owner. Under the
proposal recommended by the comments, section 59A would not apply to
any less than 100 percent owned affiliate, so long as other ``public''
shareholders owned some interest in the corporation. The corporate laws
of a state of the United States or a foreign jurisdiction may, and
often do, impose certain duties on the board of directors of a company,
including obligations with respect to the interests of minority
shareholders. These companies are also subject to securities laws in
the United States. Notwithstanding this regulatory environment, the
Code includes many provisions that apply to related parties, and none
of those provisions are limited to corporations that are 100 percent
related.
For example, section 267(a) generally applies to transactions among
greater than 50 percent controlled parties. Section 482 provides a test
that can be satisfied by a quantitative measure of ownership or a
qualitative test of control (``two or more organizations, trades, or
businesses . . . owned or controlled directly or indirectly by the same
interests''), that, as interpreted by regulations, can apply at well
below a 100 percent relatedness standard. See Sec. 1.482-1(i)(5).
Other sections of the
[[Page 66969]]
Code apply based on a relatedness standard of 80 percent. See,
generally, section 1504; section 351(a). In section 59A, Congress
adopted, disjunctively, both the 50 percent relatedness-test from
section 267(a) and the relatedness-test from section 482. Moreover,
Congress also added, disjunctively, a lower objective standard for
determining relatedness for a 25-percent owner.
Finally, the Treasury Department and IRS concluded that a rule that
confers special status on payments to a publicly traded foreign
corporation that is related (using a 25 percent or greater standard) to
the payor would not be analogous to the rules in Sec. 1.367(e)-1(d)(3)
or Sec. 1.382-2T(j), which provide special rules that pertain to
shareholders that own less than 5 percent of publicly traded
corporations, in light of challenges in determining the identity of
such shareholders.
For these reasons, the final regulations do not modify the
relatedness thresholds that are set forth in section 59A and the
proposed regulations.
III. Comments and Changes to Proposed Sec. 1.59A-2--Applicable
Taxpayer, Aggregation Rules, Gross Receipts Test, and Base Erosion
Percentage Test
Proposed Sec. 1.59A-2 contains rules for determining whether a
taxpayer is an applicable taxpayer on which the BEAT may be imposed,
including rules relating to the gross receipts test, base erosion
percentage test, and the determination of the aggregate group for
purposes of applying these tests.
A. Determining the Gross Receipts and Base Erosion Percentage of an
Aggregate Group That Includes a RIC, a REIT, or an Entity Treated as a
Corporation by Section 892
Section 59A(e)(1)(A) excludes corporations that are (1) regulated
investment companies (``RICs''), (2) real estate investment trusts
(``REITs''), or (3) S corporations from the definition of an applicable
taxpayer. A comment requested that the final regulations clarify that
controlled RICs and REITs are similarly excluded from the aggregate
group for purposes of the gross receipts test and base erosion
percentage test. The comment implied that the Treasury Department and
the IRS did not intend for RICs and REITs to be part of an aggregate
group because RICs and REITs are not subject to the BEAT as separate
taxpayers. The proposed regulations do not exclude RICs and REITs from
membership in an aggregate group. A corporation is an applicable
taxpayer if it is not one of the excluded categories of corporations
(RIC, REIT, or S corporation), it satisfies the gross receipts test in
section 59A(e)(1)(B), and it satisfies the base erosion percentage test
in section 59A(e)(1)(C). The proposed regulations provide that when
applying the gross receipts test and the base erosion percentage test
with respect to a particular corporation for purposes of section 59A,
those tests are applied on the basis of that corporation and members of
that corporation's aggregate group. The proposed regulations define an
aggregate group by reference to section 1563(a) in a manner consistent
with section 59A(e)(3), which references section 1563(a) indirectly.
The section 1563(a) definition refers to controlled groups of
corporations, whether brother-sister groups or parent-subsidiary
groups. Section 1563(c) provides special rules excluding certain
categories of stock in a corporation from the aggregation rules in
section 1563(a) (for example, certain stock held by an organization to
which section 501 applies). None of those provisions exclude the stock
of, or held by, a RIC or REIT. Moreover, just as the gross receipts and
deductions of non-applicable taxpayers (such as partnerships) can inure
to the benefit of an applicable taxpayer (such as a domestic
corporation that is a partner in a partnership), so too can the gross
receipts and deductions of a controlled RIC or REIT that is a member of
a corporation's aggregate group inure to the benefit of that
corporation. Because of these considerations, the final regulations do
not adopt this recommendation.
Similarly, another comment requested that the final regulations
exclude from the aggregate group foreign government owners of stock of
corporations when the foreign government is treated as a corporation
under section 892 and the regulations thereunder. The comment cited the
exclusion from section 1563(a) of certain stock held by an organization
to which section 501 applies, and suggested that a foreign government
should be provided similar treatment because a foreign government, like
a section 501 organization, does not have private shareholders. In
addition, the comment asserted that it cannot be engaged in direct
commercial activities with respect to its portfolio companies and that
its investment managers consist of separate teams.
The Treasury Department and the IRS have determined that it is not
appropriate to provide a regulatory exception from the aggregate group
rules for entities that are commonly controlled by a foreign government
shareholder and that are treated as corporations under section 892.
Congress provided that the activities of an aggregate group are fully
taken into account when applying the gross receipts test and the base
erosion percentage test to a corporation. The fact that a common
shareholder of a different chain of corporations may be more passive
than other common shareholders, or that the common shareholder's
investment teams are within different lines of a management structure
does not change the fact the common shareholder has economic interests
in the subsidiary corporation that is within the statutory aggregate
group definition adopted for section 59A. Accordingly, the final
regulations do not adopt this recommendation.
B. Gross Receipts From Certain Inventory and Similar Transactions
To determine gross receipts, section 59A(e)(2)(B) provides for
``rules similar to the rules'' of section 448(c)(3)(B), (C), and (D).
Accordingly, these final regulations provide rules that are similar to,
but not necessarily the same as, the rules of section 448(c)(3) and the
implementing regulations. Proposed Sec. 1.59A-1(b)(13) defines the
term ``gross receipts'' for purposes of section 59A by reference to
Sec. 1.448-1T(f)(2)(iv), which provides that gross receipts include
total sales, net of returns and allowances, and all amounts received
for services. Section 1.448-1T(f)(2)(iv) further provides that gross
receipts are not reduced by cost of goods sold (``COGS'') or reduced by
the cost of property sold if such property is described in section
1221(a)(1), (3), (4), or (5) (types of property excluded from the
definition of a capital asset). Separately, Sec. 1.448-1T(f)(2)(iv)
provides that gross receipts from the sale of capital assets or a sale
of property described in section 1221(a)(2) (relating to property used
in a trade or business) are reduced by the adjusted basis of the
property sold. Section 1.448-1T(f)(2)(iv) further provides that gross
receipts include income from investments, but not the repayment of a
loan or similar instrument.
Comments observed that, pursuant to the definition of gross
receipts in the proposed regulations, banks that originate and then
sell loans are required to include the gross proceeds from the sale of
the loan in their gross receipts because banks generally treat loans
originated in the ordinary course of business as ordinary assets under
section 1221(a)(4). These comments contrasted a situation where a bank
originates and holds a loan to maturity, in which case the proceeds the
bank receives upon repayment are not
[[Page 66970]]
included in gross receipts due to the express exclusion of these
amounts contained in Sec. 1.448-1T(f)(2)(iv). The comments recommended
that the regulations provide for a separate reduction of gross receipts
from the sale of a loan for the basis in loans originated by a bank.
Another comment recommended a similar exception for a bank or broker-
dealer that holds stocks and bonds in inventory. This comment proposed
that final regulations permit banks and broker-dealers to reduce gross
receipts from ordinary course sales of stocks and bonds by the basis of
these instruments. The comment also observed that the gains or losses
recognized with respect to the stocks and bonds are from sales in the
ordinary course and may be small relative to the cost basis in the
property.
The final regulations do not adopt the approach suggested by these
comments. The final regulations continue to define the term ``gross
receipts'' by cross-referencing to Sec. 1.448-1T(f)(2)(iv), and those
rules are used to determine how an item is included in gross receipts.
The rules in section 59A for implementing the gross receipts test are
similar to the rules described in section 448(c). See section 59A(e)(3)
(adopting an aggregation rule similar to that in section 448(c)(2));
section 59A(e)(2)(B) (specifically cross-referencing rules similar to
section 448(c)(3)(B), (C), and (D) for the treatment of short taxable
years, reductions for returns and allowances, and predecessors,
respectively); and section 59A(e)(2)(A) (adopting a broad concept of
gross receipts, narrowed to exclude gross receipts of a foreign person
that are not taken into account in determining income that is
effectively connected with the conduct of a trade or business within
the United States). Because of this statutory link between section
59A(e)(2) and section 448, the final regulations adopt the definition
of gross receipts for purposes of section 59A that is used for section
448 purposes--that is, the definition in Sec. 1.448-1T(f)(2)(iv).
Because the Act includes other new rules that cross-reference section
448, the Treasury Department and the IRS are studying section 448
generally and whether changes should be made to the regulations under
section 448 to take into account the Act.
C. Determining the Aggregate Group for Purposes of Applying the Gross
Receipts Test and Base Erosion Percentage Test
Section 59A determines the status of a corporation as an applicable
taxpayer on the basis of the aggregate group rules by taking into
account the gross receipts and base erosion payments of each member of
the aggregate group. However, each taxpayer must compute the amount of
gross receipts and base erosion payments for its aggregate group using
its own taxable year and based on those corporations that are members
of the aggregate group at the end of the taxable year. See section
59(e)(3). Therefore, members with different taxable years may have
different base erosion percentages.
1. Members of an Aggregate Group With Different Taxable Years
The proposed regulations provide rules for determining whether the
gross receipts test and base erosion percentage test are satisfied for
purposes of section 59A with respect to a specific taxpayer when other
members of its aggregate group have different taxable years. See
proposed Sec. 1.59A-2(e)(3)(vii). In general, the proposed regulations
provide that, for purposes of section 59A only, each taxpayer
determines its gross receipts and base erosion percentage by reference
to its own taxable year, taking into account the results of other
members of its aggregate group during that taxable year. In other
words, the gross receipts, base erosion tax benefits, and deductions of
the aggregate group for a taxable year are determined by reference to
the taxpayer's own taxable year, without regard to the taxable year of
the other member. This rule applies regardless of whether the taxable
year of the member begins before January 1, 2018; as a result, a
taxpayer includes gross receipts, base erosion tax benefits, and
deductions of the member even if that member is not subject to section
59A for that taxable year. The proposed regulations adopted this
approach to reduce compliance burden through providing certainty for
taxpayers and avoid the complexity of a rule that identifies a single
taxable year for an aggregate group for purposes of section 59A that
may differ from a particular member of the aggregate group's taxable
year. As a result, under the proposed regulations, two related
taxpayers with different taxable years may compute their respective
gross receipts and base erosion percentages for purposes of section 59A
by reference to different periods, even though each taxpayer calculates
these amounts on an aggregate group basis that takes into account other
members of the controlled group. The preamble to the proposed
regulations explains that taxpayers may use a reasonable method to
determine the gross receipts and base erosion percentage information
with regard to the taxable year of the taxpayer when members of the
aggregate group of the taxpayer have a different taxable year. REG-
104259-18, 83 FR 65956, 65959 (December 21, 2018).
Comments expressed concern regarding the potential administrative
burdens of treating all members of a taxpayer's aggregate group as
having the same taxable year as the taxpayer. These comments argued
that, in many cases, companies do not maintain monthly accounting
records as detailed as they do on a quarterly basis (for publicly
traded companies) or an annual basis (for privately held companies).
Also, comments noted that this rule does not take into account the
effect of deductions that are determined on a yearly basis or subject
to annual limitations, such as under section 163(j).
Comments requested that the determination of gross receipts and the
base erosion percentage of a taxpayer's aggregate group be made on the
basis of the taxpayer's taxable year and the taxable year of each
member of its aggregate group that ends with or within the applicable
taxpayer's taxable year (the ``with-or-within method''). With respect
to members of an aggregate group with different taxable years, the
Treasury Department and the IRS appreciate the concerns raised
regarding the potential administrative burden of proposed Sec. 1.59A-
2(e)(3)(vii) and believe that the approach described in the comments
represents a reasonable approach. The final regulations, therefore,
adopt the with-or-within method, for purposes of section 59A only, to
determine the gross receipts and the base erosion percentage of an
aggregate group. See Sec. 1.59A-2(c)(3). In addition, the Treasury
Department and the IRS are issuing a notice of proposed rulemaking (the
``2019 proposed regulations'') published in the same issue of the
Federal Register as these final regulations that proposes rules to
further address how to implement the with-or-within method, and how to
take into account the changing composition of the aggregate group with
respect to a particular taxpayer during the relevant periods for
applying the gross receipts test and the base erosion percentage test.
The final regulations do not include rules on predecessors or short
taxable years. Instead, rules relating to these situations have been
re-proposed in the 2019 proposed regulations. Until final rules are
applicable relating to predecessors or short taxable years, taxpayers
must take a reasonable approach consistent with section 59A(e)(2)(B) to
determine gross receipts and base erosion benefits in these situations.
[[Page 66971]]
2. Time for Determining That Transactions Occurred Between Members of
the Aggregate Group
The proposed regulations provide that, for purposes of section 59A,
transactions that occur between members of the aggregate group that
were members of the aggregate group at the time of the transaction are
not taken into account for purposes of determining the gross receipts
and base erosion percentage of an aggregate group. See proposed Sec.
1.59A-2(c). In the case of a foreign corporation that is a member of an
aggregate group, only transactions that relate to income effectively
connected with the conduct of a trade or business in the United States
are disregarded for this purpose. The preamble to the proposed
regulations explains that this limitation on the extent to which
foreign corporations are included in the aggregate group is intended to
prevent payments from a domestic corporation, or a foreign corporation
with respect to effectively connected income, to a foreign related
person, from being inappropriately excluded from the base erosion
percentage test. REG-104259-18, 83 FR 65956, 65957 (December 21, 2018).
A comment requested clarity on determining whether transactions
between members of an aggregate group are disregarded. Specifically,
the comment requested clarity on whether a transaction is disregarded
when both parties to the transaction are members of the aggregate group
at the time of the transaction, or whether it is also a condition that
both parties to the transaction must also be members of the aggregate
group on the last day of the taxpayer's taxable year.
As requested by the comment, the final regulations clarify that a
transaction between parties is disregarded for purposes of section 59A
when determining the gross receipts and base erosion percentage of an
aggregate group if both parties were members of the aggregate group at
the time of the transaction, without regard to whether the parties were
members of the aggregate group on the last day of the taxpayer's
taxable year. See Sec. 1.59A-2(c)(1).
3. Base Erosion Tax Benefits and Deductions of a Member of an Aggregate
Group With a Taxable Year Beginning Before January 1, 2018
For purposes of determining the base erosion percentage, comments
also expressed concern about including the base erosion tax benefits
and deductions of a member when the taxable year of the member begins
before January 1, 2018. The comments noted that this taxable year of
the member is not otherwise subject to section 59A because of the
effective date in section 14401(e) of the Act. However, one comment
agreed with including these base erosion tax benefits and deductions in
the aggregate group of a taxpayer for a taxable year of the taxpayer to
which section 59A applies.
The Treasury Department and the IRS agree with comments that it is
not appropriate for a taxpayer to include base erosion tax benefits and
deductions attributable to a taxable year of a member of its aggregate
group that begins before the effective date of section 59A when
determining the base erosion percentage of the aggregate group.
Accordingly, when determining the base erosion percentage of an
aggregate group, the final regulations exclude the base erosion tax
benefits and deductions attributable to the taxable year of a member of
the aggregate group that begins before January 1, 2018. See Sec.
1.59A-2(c)(8). This rule avoids requiring members of an aggregate group
to calculate their hypothetical base erosion tax benefits for a year in
which the base erosion tax benefit rules do not apply.
4. Other Comments Regarding the Aggregate Group Rules
Comments also addressed the following issues with respect to the
aggregate group rules in the proposed regulations: (1) How to take into
account transactions when a member joins or leaves an aggregate group,
(2) the treatment of predecessors of a taxpayer, (3) the determination
of the aggregate group of a consolidated group, and (4) the treatment
of short taxable years. The Treasury Department and the IRS continue to
study the recommendations provided in several comments relating to
these issues. Therefore, the Treasury Department and the IRS are
issuing the 2019 proposed regulations to further address aggregate
group issues.
D. Mark-to-Market Deductions
To determine the base erosion percentage for the year, the taxpayer
(or in the case of a taxpayer that is a member of an aggregate group,
the aggregate group) must determine the amount of base erosion tax
benefits in the numerator and the total amount of certain deductions,
including base erosion tax benefits, in the denominator. The proposed
regulations provide rules for determining the total amount of the
deductions that are included in the denominator of the base erosion
percentage computation in the case of transactions that are marked to
market. In determining the amount of the deduction that is used for
purposes of the base erosion percentage test, the proposed regulations
require the combination of all items of income, deduction, gain, or
loss on each marked transaction for the year (``the BEAT Netting
Rule''), such as from a payment, accrual, or mark. See proposed Sec.
1.59A-2(e)(3)(vi). The BEAT Netting Rule was adopted to ensure that
only a single deduction is claimed with respect to each marked
transaction and to prevent distortions in deductions from being
included in the denominator of the base erosion percentage, including
as a result of the use of an accounting method that values a position
more frequently than annually.
A comment requested guidance clarifying whether the BEAT Netting
Rule applies to physical securities such as stocks, bonds, repurchase
agreements, and securities loans with respect to which a taxpayer
applies a mark-to-market method of accounting. The comment questioned
whether the BEAT Netting Rule should apply to these types of positions.
The comment acknowledged that the BEAT Netting Rule produces an
appropriate result with respect to derivatives by avoiding double-
counting of both a current mark-to-market loss as well as a future
payment to which the current loss relates. Unlike in the case of many
derivatives, the comment observed that transactions involving stocks,
bonds, repurchase agreements, and securities loans generally do not
result in a loss of value to the holder of the relevant instrument that
is subsequently realized in the form of a payment made by the holder
and that effectively gives rise to an offsetting mark-up of the
instrument.
To illustrate this observation, the comment provided the following
example. On January 1, 2018, a dealer buys one share of stock in
Company XYZ for $100. Then, during 2018, Company XYZ pays dividends of
$1 with respect to the share. On December 31, 2018, the share price of
Company XYZ is $90. Finally, on January 1, 2019, the dealer sells the
share of Company XYZ stock for $90. The comment noted that in the
absence of the BEAT Netting Rule, the amount of the dealer's deduction
after marking the stock to market on December 31, 2018, would be $10.
With the application of the BEAT Netting Rule, however, the comment
noted that the amount of the deduction that will be included in the
base erosion percentage denominator is $9. According to this comment,
the BEAT Netting Rule may not be necessary to avoid the double-counting
of deductions
[[Page 66972]]
in these transactions, and could result in the netting of amounts that
would not be netted under section 475 and that are not duplicative of
other inclusions or deductions by the taxpayer.
Proposed Sec. 1.59A-2(e)(3)(vi) applies to any position with
respect to which the taxpayer (or in the case of a taxpayer that is a
member of an aggregate group, a member of the aggregate group) applies
a mark-to-market method of accounting. Therefore, the BEAT Netting Rule
in the proposed regulations applies to stocks, bonds, repurchase
agreements, and securities lending transactions that the taxpayer marks
to market, rendering further clarification unnecessary. The Treasury
Department and the IRS have determined that the applicability of the
BEAT Netting Rule should not be limited in the manner suggested by the
comment. In addition to avoiding the double counting that the comment
acknowledged, the proposed regulations adopt the BEAT Netting Rule to
enhance administrability and reduce compliance burden. That is, having
a single rule apply to all transactions that are marked to market will
enhance administrability, especially given the challenges in (a)
distinguishing the specific financial transactions that should qualify
for exclusion; (b) determining whether a distribution or payment
received on an excluded instrument is duplicative of other inclusions
or deductions; and (c) determining the extent to which a payment
ultimately gives rise to an offsetting decline in the value of the
instrument. For these reasons, the BEAT Netting Rule in the final
regulations does not exclude physical securities.
Another comment recommended that the BEAT Netting Rule should not
be mandatory and should instead be included in the final regulations as
only a safe harbor. The comment reasoned that section 59A is generally
applied on a gross basis and that requiring taxpayers to offset
deductions and losses with income and gain when determining the base
erosion percentage is inconsistent with a gross approach. The BEAT
Netting Rule was adopted to ensure that taxpayers do not overstate the
amount of deductions includible in the denominator with respect to
transactions subject to a mark-to-market method of accounting. If the
BEAT Netting Rule were provided as a safe harbor in the final
regulations, as this comment requested, taxpayers could inappropriately
inflate the denominator of the base erosion percentage by treating
multiple marks as separate deductions. Therefore, the final regulations
do not adopt this comment.
As discussed in Part III.D of this Summary of Comments and
Explanation of Revisions, the taxpayer must also determine the amount
of base erosion tax benefits in the numerator to determine the base
erosion percentage for the year. Proposed Sec. 1.59A-3(b)(2)(iii) also
applies the BEAT Netting Rule for purposes of determining the amount of
base erosion payments that result from transactions that are marked to
market. A comment expressed concern that this rule could result in
mark-to-market losses being treated as base erosion payments and
recommended the withdrawal of proposed Sec. 1.59A-3(b)(2)(iii),
although the comment observed that if the Treasury Department and the
IRS were to adopt the comment to make the qualified derivative payments
(``QDP'') exception available to securities loans (which is discussed
in Part VII of this Summary of Comments and Explanation of Revisions),
that change would make this issue moot. The Treasury Department and the
IRS do not view this concern to be valid, considering that a mark-to-
market loss arising from a deemed sale or disposition of a third-party
security held by a taxpayer is not within the general definition of a
base erosion payment because the loss is not attributable to any
payment made to a foreign related party. Rather, the mark-to-market
loss is attributable to a decline in the market value of the security.
The Treasury Department and the IRS also note that the BEAT Netting
Rule will apply primarily for purposes of determining the amount of
deductions that are taken into account in the denominator of the base
erosion percentage. The Treasury Department and the IRS agree with the
comment that the QDP exception of Sec. 1.59A-3(b)(3)(ii) eliminates
most mark-to-market transactions from characterization as a base
erosion payment, including as a result of the expansion of the QDP
exception to apply to the securities leg of a securities loan. See Part
VII of this Summary of Comments and Explanation of Revisions for a
discussion of the qualification of the securities leg of a securities
loan for the QDP exception. Thus, the BEAT Netting Rule will apply only
in limited circumstances such as when the taxpayer fails to properly
report a QDP. The final regulations therefore continue to apply the
BEAT Netting Rule for purposes of determining the amount of base
erosion payments that result from transactions that are marked to
market.
IV. Comments and Changes to Proposed Sec. 1.59A-3--Base Erosion
Payments and Base Erosion Tax Benefits
Proposed Sec. 1.59A-3 contains rules for determining whether a
payment or accrual gives rise to a base erosion payment and the base
erosion tax benefits that arise from base erosion payments.
A. How Base Erosion Payments Are Determined in General
Proposed Sec. 1.59A-3(b)(1) defines a base erosion payment as a
payment or accrual by the taxpayer to a foreign related party that is
described in one of four categories: (1) A payment with respect to
which a deduction is allowable; (2) a payment made in connection with
the acquisition of depreciable or amortizable property; (3) premiums or
other consideration paid or accrued for reinsurance that is taken into
account under section 803(a)(1)(B) or 832(b)(4)(A); or (4) a payment
resulting in a reduction of the gross receipts of the taxpayer that is
with respect to certain surrogate foreign corporations or related
foreign persons.
The Conference Report to the Act states that base erosion payments
do not include any amounts that constitute reductions to determine
gross income including payments for COGS (except for reductions to
determine gross income for certain surrogate foreign corporations).
Conf. Rep. at 657. The proposed regulations do not contain a provision
that expressly provides that amounts paid or accrued to a related
foreign person that result in reductions to determine gross income are
not treated as base erosion payments (except in the case of certain
surrogate foreign corporations). A comment requested that, in order to
provide more certainty to taxpayers, the final regulations expressly
reflect that payments that result in reductions to determine gross
income are not subject to section 59A. In response to this comment,
Sec. 1.59A-3(b) has been modified to explicitly clarify that payments
resulting in a reduction to determine gross income, including COGS, are
not treated as base erosion payments within the meaning of section
59A(d)(1) or (2). See Sec. 1.59A-3(b)(2)(viii).
The proposed regulations do not establish any specific rules for
determining whether a payment is treated as a deductible payment.
However, the preamble to the proposed regulations states that, except
as otherwise provided in the proposed regulations, the determination of
whether a payment or accrual by the taxpayer to a foreign related party
is
[[Page 66973]]
described in one of the four categories is made under general U.S.
federal income tax law. REG-104259-18, 83 FR 65956, 65959 (December 21,
2018). The preamble to the proposed regulations refers specifically to
agency principles, reimbursement doctrine, case law conduit principles,
and assignment of income as examples of principles of generally
applicable tax law. Id. A comment noted the potential for ambiguity
that could result by failing to reflect in the text of the proposed
regulations the language contained in the preamble to the proposed
regulations and requested that the final regulations provide more
specific guidance on how the determination of whether a payment is a
base erosion payment is made. In response to this comment, the final
regulations include in the regulatory text a rule that the
determination of whether a payment or accrual is a base erosion payment
is made under general U.S. federal income tax law. See Sec. 1.59A-
3(b)(2)(i).
Similarly, because existing tax law generally applies, the amounts
of income and deduction for purposes of section 59A are generally
determined on a gross basis under the Code and regulations. The
proposed regulations generally do not permit netting of income and
expense in determining amounts of base erosion payments. Comments to
the proposed regulations requested guidance regarding (1) transactions
involving a middle-man or a passthrough payment, (2) divisions of
revenues in connection with global service arrangements, and (3) the
general netting of income and expense.
1. Transactions Involving a ``Middle-Man'' or ``Passthrough Payments''
Several comments requested additional guidance relating to
transactions or arrangements in which a taxpayer serves as a so-called
middle-man for a payment to a foreign related party or makes a so-
called passthrough payment to a foreign related party that may
frequently arise in connection with global services and similar
businesses. Broadly, the comments considered situations where a
domestic corporation makes a deductible payment to a foreign related
party, and that foreign related party in turn makes corresponding
payments to unrelated third parties. Comments that addressed this
concern arose in a variety of industries and business models. In some
situations, the comments observed that business exigencies require the
domestic corporation to make payments to the foreign related party. For
example, in a business involving the physical delivery of goods within
a foreign jurisdiction, a domestic corporation may subcontract with its
foreign related party to perform the foreign in-country delivery
function. Another example involves global service contracts that may be
entered into by a domestic corporation and a client that does business
in multiple jurisdictions, and may require services in connection with
the client's global operations that are also subcontracted to foreign
related parties. Some more specific comments observed that this global
services situation may arise in connection with U.S.-based
manufacturers that sell manufactured products to unrelated global
customers and simultaneously enter into contracts to provide services
for the product in multiple jurisdictions in connection with the sale
of equipment. The comments observed that these service contracts, like
other global services contracts, frequently involve subcontracting with
a foreign related party to perform the services in foreign
jurisdictions.
Multiple comments requested that the final regulations provide that
the definition of a base erosion payment does not include payments made
pursuant to a contract when a taxpayer makes a corresponding payment to
a foreign related party for third party costs. Other comments requested
that the final regulations more specifically exempt the types of
business models discussed in the comment letters. For example, some
comments recommended that the final regulations provide an exception to
the term ``base erosion payment'' for payments made by a taxpayer to a
foreign related party with respect to services performed for an
unrelated party, provided that the foreign related party performs the
services outside of the United States. Other comments recommended a
similar exception that would apply only to services that are performed
in connection with tangible property produced or manufactured by the
taxpayer (or a related party). These comments observed that Congress
intended to exclude manufacturers from the BEAT because it effectively
created an exception for COGS, and that this exception should be
carried through to services in connection with manufacturing.
Other comments recommended an exception to the definition of base
erosion payment for payments to foreign related parties that are
mandated under regulatory requirements. In other situations, comments
observed that regulatory considerations affect the decision by the
domestic corporation to make a payment to the foreign related party. An
example includes a global dealing operation where a U.S. securities
dealer has a client who wants to trade its securities on a foreign
securities exchange that requires a locally registered dealer; for
those trades, a foreign related party of the U.S. securities dealer
conducts those trades. Other examples involving regulatory
considerations include U.S. life sciences companies that, in connection
with obtaining food and drug approval to sell a product in a foreign
market, use a foreign related party to conduct clinical trials in that
market because foreign regulators require testing on local patients.
The final regulations do not adopt a general exception to the
definition of a base erosion payment in situations when the foreign
related payee also makes payments to unrelated persons. The BEAT
statute and the legislative history contain no indication of such an
exception. Moreover, this recommended exception is inconsistent with
the statutory framework of the BEAT. If traced to the ultimate
recipient, most expenses of a taxpayer could be linked to a payment to
an unrelated party, through direct tracing or otherwise, leaving a
residual of profit associated with the payment. Accordingly, adopting
such an exception would have the effect of eliminating a significant
portion of service payments to foreign related parties from the BEAT
because it would impose the BEAT on the net rather than the gross
amount of the payment. The only net income based concept included in
the BEAT statute is the treatment of payments covered by the services
cost method (``SCM'') exception. For a further discussion of the SCM
exception, see Part IV.C.1 of this Summary of Comments and Explanation
of Revisions.
The final regulations also do not adopt a narrower regulatory
exception for payments that arise in similar circumstances but that are
also associated with manufacturing or the production of tangible
property. The Treasury Department and the IRS do not view the presence
or absence of manufacturing as bearing on the statutory definition of a
base erosion payment for services. Further, the Treasury Department and
the IRS do not view the fact that payments that reduce gross receipts,
such as COGS, are not base erosion payments under section 59A(d)(1) as
demonstrating Congressional intent to exclude services that do not
qualify as COGS from the definition of a base erosion payment under
section 59A(d)(1) if those services have a connection to manufacturing
operations. Congress included a single specific exception for
services--the SCM exception. For a further discussion
[[Page 66974]]
of that exception, see Part IV.C.1 of this Summary of Comments and
Explanation of Revisions.
The final regulations do not adopt a narrower exception for
payments to foreign related parties that arise because of non-tax
business considerations, including a non-tax foreign regulatory
requirement. The Treasury Department and the IRS recognize that there
may be non-tax reasons that compel a taxpayer to perform a particular
global service outside the United States. For example, an international
delivery service may need to engage a foreign related party in the
destination country to deliver goods in a foreign jurisdiction.
The final regulations do not adopt this recommended exception
because it would require rules to distinguish between the conditions
under which a domestic corporation is compelled to operate through a
foreign related party and the conditions under which a domestic
corporation operates through a foreign related party as a result of a
business choice. This distinction would be inherently subjective. For
example, in a global service business that provides services to a
global client that has operations around the world, the decision to
provide personnel on-site in a foreign location may or may not be
compelled by the business needs of its client. Similarly, in the case
of the back-office functions of a global services business, those
functions may be performed in the United States or in a location
outside of the United States; the location of those services may or may
not be compelled by the business needs of their client. Moreover, even
if there is a compelling reason to operate the activities outside the
United States, a base erosion payment exists only if a taxpayer makes a
payment to a foreign related party. Thus, if a foreign branch of the
domestic corporation performs services in the foreign jurisdiction,
there will be no payment or accrual to a foreign related party.
Finally, there is no indication that Congress intended to create a
broad services exception, outside of the SCM exception, even though
these global services conditions are common in the modern economy.
2. Division of Revenues From Global Services
Comments requested that final regulations provide an exception from
the term ``base erosion payment'' for revenue sharing payments or
arrangements, including allocations with respect to global dealing
operations. Specifically, some comments recommended that the final
regulations provide that a payment is not a base erosion payment in a
situation where the domestic corporation records revenue from
transactions with third party customers, and in turn the domestic
corporation makes payments to a foreign related party. Other comments
recommended that payments by the domestic corporation to foreign
related parties should not be base erosion payments if the parties have
adopted a profit split as their best method of pricing the related-
party transactions for purposes of section 482. Some of these comments
asserted that parties to such payments could be viewed as splitting the
customer revenue for purposes of section 59A. Under this view, the
payments received by the foreign related party would be treated as
received directly from the third-party customer, with the result that
there would be no corresponding deductible payment from the domestic
corporation to the foreign related party.
Other comments more specifically addressed this issue in the
narrower context of a global dealing operation within the meaning of
proposed Sec. 1.482-8(a)(2)(i). These comments requested that payments
made pursuant to a global dealing operation not be treated as base
erosion payments.
The final regulations do not adopt the recommendations to
specifically exclude from the definition of a base erosion payment
transactions that are priced based on the profit split or similar
transfer pricing method that is used for purposes of section 482. Under
section 482, the parties to a controlled transaction apply the best
method to determine if the parties are compensated at arm's length.
However, the use of a particular method, whether the profit split
method or another method, does not change the contractual relationship
between the parties. Accordingly, the final regulations do not adopt
this recommendation because the proper characterization depends on the
underlying facts and the relationships between the parties. See Sec.
1.59A-3(b)(2).
Similarly, with respect to a global dealing operation, the final
regulations do not adopt the comment to provide that global dealing
operations do not give rise to base erosion payments because the proper
characterization depends on the underlying facts. Under general tax
principles, and consistent with proposed Sec. 1.863-3(h), a global
dealing operation in which participants manage a single book of assets,
bear risk, and share in trading profits may be viewed as co-ownership
of the trading positions or similar arrangement, with no deductible
payments made by any participants for purposes of section 59A. In
contrast, where non-U.S. participants are compensated for services
performed, the arrangement may be more properly characterized as
trading income to the U.S. participant and a deductible payment to the
foreign participant for purposes of section 59A.
To the extent that an amount is treated under general U.S. federal
income tax law as received by a U.S. person as an agent for, and is
remitted to, a foreign related party, see also Part IV.A (How Base
Erosion Payments are Determined in General) of this Summary of Comments
and Explanation of Revisions, which discusses the addition of Sec.
1.59A-3(b)(2)(i) to clarify that the determination of whether a payment
or accrual by the taxpayer to a foreign related party is described in
one of four categories of a base erosion payment is made under general
U.S. federal income tax law, including agency principles.
3. Netting of Income and Expense
Proposed Sec. 1.59A-3(b)(ii) generally states that the amount of
any base erosion payment is determined on a gross basis, regardless of
any contractual or legal right to make or receive payments on a net
basis, except as otherwise provided in paragraph (b)(2)(iii) of that
section, which addresses mark-to-market positions, or as permitted by
the Code or regulations. As explained in the preamble to the proposed
regulations, the BEAT statutory framework is based on including the
gross amount of base erosion payments in the BEAT's expanded modified
taxable income base. REG-104259-18, 83 FR 65956, 65968 (December 21,
2018).
a. In General
Numerous comments recommended that the final regulations permit
netting for purposes of section 59A. Generally, netting would allow a
taxpayer to determine the amount of a base erosion payment by reducing
the amount of that payment by the amount of another corresponding
obligation.
A comment asserted that netting should be permitted for all base
erosion payments other than with respect to reinsurance payments. The
comment explained that the plain language of section 59A(d)(1) provides
that only amounts paid or accrued are taken into account; this comment
interpreted this language to mean the net amount paid or accrued.
Because section 59A(d)(3) refers to gross premiums in the reinsurance
context, the comment maintained that netting is permitted for other
base erosion payments. This comment also noted that netting was
provided under proposed section 4491, an inbound base erosion provision
[[Page 66975]]
included in section 4303 of the House version of H.R. 1, before the
Senate amended H.R.1 to include the BEAT in place of proposed section
4491. This comment also recommended that netting be permitted because
other sections of the Code or regulations include netting concepts,
such as sections 163(j), 250 and 951A, and the aggregation rule in
Sec. 1.482-1T(f)(2)(i)(B).
Some comments recommended that the final regulations permit netting
when the foreign related party payee has a corresponding obligation to
make payments to an unrelated third party payee. Some of these comments
asserted that base erosion payments arise because of commercial and
regulatory efficiency and expediency, rather than because of tax
planning. These comments recommended that netting be permitted in
ordinary course transactions. Other comments recommended that the final
regulations permit netting for deductible amounts owed by a domestic
corporation to a foreign related party if the foreign related party
also owes amounts to the domestic corporation and the obligations are
settled on a net basis.
The Treasury Department and the IRS have determined that it is
appropriate to retain the approach in the proposed regulations that the
amount of a base erosion payment is determined on a gross basis, except
as provided in the BEAT Netting Rule and to the extent permitted by the
Code or regulations. See part III.D of this Summary of Comments and
Explanation of Revisions (Mark-to-market deductions). As explained in
the preamble to the proposed regulations, amounts of income and
deduction are generally determined on a gross basis under the Code.
REG-104259-18, 83 FR 65956, 65968 (December 21, 2018). For example,
whether the amount of income or deductions with respect to financial
contracts that provide for offsetting payments is taken into account on
a gross or net basis is determined under generally applicable federal
income tax law. Section 59A does not change that result.
The final regulations are consistent with the statutory framework
of section 59A. Section 59A specifically addresses deductible payments
and other statutorily defined base erosion payments, and imposes tax on
an increased base of modified taxable income, but at a lower tax rate
than the corporate income tax rate set forth in section 11. If
regulations provided that statutorily defined base erosion payments
could be reduced by offsetting amounts received, then the regulations
would substantially limit the scope of section 59A. Section 11 imposes
a tax on a corporation's taxable income. Taxable income is defined as
gross income minus the deductions allowed by chapter 1 of the Code.
Section 63. Gross income is generally defined as income from whatever
source derived. Section 61. The amount of income and deductions are
generally determined on a gross basis under the Code. Nothing in
section 59A evidences Congressional intent to alter this framework. In
fact, section 59A(c) determines modified taxable income from the
starting point of taxable income as defined in section 63.
A netting rule would have the same effect as allowing a deduction
from gross income because it would reduce the amount of a taxpayer's
modified taxable income, and in that sense would conflict with section
59A(c)(1) (disallowing a deduction for base erosion tax benefits).
Congress determined that certain deductions, namely those that are
within the statutory definition of a base erosion payment, should not
be allowed for purposes of the tax imposed under section 59A, and
therefore, limited the availability of these deductions. Permitting
netting of items of gross income and deductions to determine the amount
of a base erosion payment would frustrate Congress' purpose in enacting
section 59A.
In addition, the other provisions of the Code and regulations that
are cited by comments are irrelevant to the analysis of section 59A and
do not provide support for adopting a netting rule for purposes of
section 59A. Whereas sections 163(j) and 951A refer explicitly to net
amounts, section 59A explicitly refers to a deduction allowable under
Chapter 1 of the Code. Section 250 provides rules for determining
whether services are for ``foreign use'' by contemplating services
provided to and from a related party that are substantially similar.
This destination-based rule is entirely different from the construct of
section 59A, and, moreover, section 59A contains no similar language
contemplating payments to and from a related party. Proposed section
4491 would have operated through the regular income tax system and
would have represented a fundamentally different approach to inbound
base erosion than section 59A; therefore, that proposed revision to the
Code is not relevant here. The aggregation rule in Sec. 1.482-
1T(f)(2)(i)(B) does not involve the treatment of payments to foreign
related parties, and thus is not relevant for purposes of analyzing the
meaning of section 59A.
Some comments also cited the heading to section 59A(h) (exception
for certain payments made in the ordinary course of trade or business)
as support for a regulatory exception for ordinary course transactions
for which a taxpayer has not adopted a mark-to-market method of
accounting. Specifically, these comments suggested that Congress did
not intend for section 59A(h)(2)(A)(i) to limit the QDP exception to
only transactions that are marked-to-market. The citations to the
heading to section 59A(h) are inconsistent with the statutory rule in
section 59A(h), which provides a narrowly defined exception applicable
to derivative payments under specific circumstances.
b. Hedging Transactions
Another comment recommended that the final regulations permit
netting in the narrow context of related-party hedging transactions.
The comment observed that the QDP exception applies to related-party
hedging transactions when the taxpayer uses a mark-to-market method of
accounting. The comment asserted that there is no policy rationale for
limiting netting relief to taxpayers that use a mark-to-market method
of accounting; therefore, the comment requested that the QDP exception
be expanded to also apply to taxpayers that apply the mark-to-market
method for financial accounting purposes. Alternatively, the comment
recommended that taxpayers engaged in related- party hedging
transactions be permitted to net income items against deduction items.
The final regulations do not provide for a netting rule for
related-party hedging transactions. As discussed in Part IV.A.3.a of
this Summary of Comments and Explanation of Revisions, permitting
netting for related-party hedging transactions would be inconsistent
with the statutory framework of section 59A. Furthermore, this
recommendation would eliminate or substantially modify one of the three
statutory requirements for the QDP exception (that is, use of the mark-
to-market accounting method).
c. Clarification of Netting Under Current Law
Finally, some comments recommended that the final regulations
clarify when netting is permitted under the Code and regulations,
including confirming that netting is permitted for notional principal
contracts and for cost sharing transaction payments under Sec. 1.482-
7(j)(3)(i). The Treasury Department and the IRS decline to provide such
specific guidance because
[[Page 66976]]
it is beyond the scope of the final regulations; however, the Treasury
Department and the IRS are cognizant that section 59A may place more
significance on some sections of the Code than was the case before the
Act. The Treasury Department and the IRS intend to study the effect of
these provisions on the BEAT and whether changes should be made to the
regulations thereunder to better take into account new considerations
under the BEAT.
B. Treatment of Certain Specific Types of Payments
1. Losses Recognized With Respect to the Sale or Transfer of Property
to a Foreign Related Party
Section 59A(d) defines a base erosion payment to include any amount
paid or accrued by a taxpayer to a foreign related party with respect
to which a deduction is allowable. Proposed Sec. 1.59A-3(b)(1)(i)
repeats this statutory language. Proposed Sec. 1.59A-3(b)(2)(i)
provides that ``an amount paid or accrued'' includes an amount paid or
accrued using any form of consideration, including cash, property,
stock, or the assumption of a liability. In explaining this provision,
the preamble to the proposed regulations states that ``a base erosion
payment also includes a payment to a foreign related party resulting in
a recognized loss; for example, a loss recognized on the transfer of
property to a foreign related party.'' REG-104259-18, 83 FR 65956,
65960 (December 21, 2018).
This principle would apply if, for example, a taxpayer transfers to
a foreign related party (a) built-in-loss property as payment for a
deductible service provided by the foreign related party to the
taxpayer (the latter of which may also be a base erosion payment), (b)
built-in-loss property as payment for a good or service that the
taxpayer is required to capitalize (for example, COGS) such that the
payment is not deductible to the taxpayer (the latter of which is not a
base erosion payment), or (c) depreciated nonfunctional currency as a
payment for a nonfunctional currency denominated amount owed by a
taxpayer.
Comments requested that the final regulations revise the definition
of a base erosion payment to exclude losses recognized on the sale or
exchange of property by a taxpayer to a foreign related party.
According to these comments, a payment made with, or a sale of, built-
in-loss property is not encompassed within the statutory definition of
a base erosion payment. Comments stated that both the statutory and
proposed regulations' definition contain two requirements for a payment
to be a base erosion payment: There must be (i) an amount paid or
accrued by the taxpayer to a foreign person that is a related party of
the taxpayer; and (ii) a deduction must be allowable with respect to
that amount.
Regarding the first requirement--that there must be an amount paid
or accrued by the taxpayer to a foreign related party--when a U.S.
taxpayer sells property to a foreign related party for cash, the
comments noted that no payment or accrual has taken place by the U.S.
taxpayer for purposes of section 59A; rather, the U.S. taxpayer is
receiving a cash payment in exchange for the transferred property, and
is not making a payment. Thus, the comments argued, the first
requirement for a base erosion payment, that a payment or accrual
exists, has not been met.
Regarding the second requirement--that a deduction must be
allowable with respect to that amount--comments argued that even if a
payment is found to have been made to the foreign related party, the
deduction for the loss on the built-in-loss property is not with
respect to this payment. That is, the comments argued that the loss
deduction is not attributable to any ``payment'' made to the foreign
related party (the form of consideration in the transaction); rather,
the loss is attributable to the taxpayer's basis in the built-in loss
property. Although that built-in-loss is recognized in connection with
the transfer to a foreign related party, and thus could meet the
statutory requirement as allowed ``with respect to'' the payment, the
comments recommended a narrower interpretation that views the
recognized loss as arising independently from the payment, that is
viewed as merely a corollary consequence unrelated to the payment being
made to the foreign related party.
The final regulations adopt the recommendation provided in these
comments. The final regulations clarify the definition of a base
erosion payment in Sec. 1.59A-3(b)(1)(i) and (b)(2)(ix) to provide
that a loss realized from the form of consideration provided to the
foreign related party is not itself a base erosion payment. For the
reasons described in the comments and discussed in this Part of the
Summary of Comments and Explanation of Revisions, this treatment aligns
the definition of base erosion payment with the economics of the
payment made by the applicable taxpayer to the foreign related party.
That is, the term ``base erosion payment'' does not include the amount
of built-in-loss because that built-in-loss is unrelated to the payment
made to the foreign related party. This rule applies regardless of
whether the loss realized from the form of consideration provided to
the foreign related party is itself consideration for an underlying
base erosion payment. To the extent that a transfer of built-in-loss
property results in a deductible payment to a foreign related party
that is a base erosion payment, the final regulations clarify that the
amount of the base erosion payment is limited to the fair market value
of that property.
2. Transfers of Property Between Related Taxpayers
The proposed regulations limit the ability of a taxpayer to
eliminate base erosion tax benefits by transferring depreciable or
amortizable property to another member of the taxpayer's aggregate
group. Specifically, proposed Sec. 1.59A-3(b)(2)(vii) provides that if
a taxpayer holds depreciable or amortizable property that produces
depreciation or amortization deductions that are base erosion tax
benefits to the taxpayer, those depreciation or amortization deductions
will continue to be treated as a base erosion tax benefit for the
acquirer if the taxpayer transfers the property to another member of
its aggregate group.
The Treasury Department and the IRS are aware of similar
transactions involving a domestic corporation that ordinarily acquires,
from a foreign related party, property that is subject to an allowance
for depreciation or amortization in the hands of the domestic
corporation. In the transaction, the domestic corporation inserts into
its supply chain a second domestic corporation, with a principal
purpose of avoiding base erosion payments. Specifically, the second
domestic corporation, a dealer in property that avails itself of the
exclusion of COGS from the definition of a base erosion payment in
section 59A(d)(1) and (2), acquires the property from the foreign
related party and in turn resells the property to the first domestic
corporation. The Treasury Department and the IRS view this type of
transaction as already within the scope of the anti-abuse rule set
forth in proposed Sec. 1.59A-9(b)(1) (transactions involving unrelated
persons, conduits, or intermediaries), and have added an example to the
final regulations clarifying the application of this anti-abuse rule to
similar fact patterns.
3. Corporate Transactions
The proposed regulations provide that a payment or accrual by a
taxpayer to a foreign related party may be a base erosion payment
regardless of whether
[[Page 66977]]
the payment is in cash or in any form of non-cash consideration. See
proposed Sec. 1.59A-3(b)(2)(i). There may be situations where a
taxpayer incurs a non-cash payment or accrual to a foreign related
party in a transaction that meets one of the definitions of a base
erosion payment, and that transaction may also qualify under certain
nonrecognition provisions of the Code. Examples of these transactions
include a domestic corporation's acquisition of depreciable assets from
a foreign related party in an exchange described in section 351, a
liquidation described in section 332, and a reorganization described in
section 368.
The proposed regulations do not include any specific exceptions for
these types of transactions even though (a) the transferor of the
assets acquired by the domestic corporation may not recognize gain or
loss, (b) the acquiring domestic corporation may take a carryover basis
in the depreciable or amortizable assets, and (c) the importation of
depreciable or amortizable assets into the United States in these
transactions may increase the regular income tax base as compared to
the non-importation of those assets. In the preamble to the proposed
regulations, the Treasury Department and the IRS also note that for
transactions in which a taxpayer that owns stock in a foreign related
party receives depreciable property from the foreign related party as
an in-kind distribution subject to section 301, there is no base
erosion payment because there is no consideration provided by the
taxpayer to the foreign related party in exchange for the property.
REG-104259-18, 83 FR 65956, 65960 (December 21, 2018). Thus, there is
no payment or accrual in that transaction.
The preamble to the proposed regulations requests comments about
the treatment of payments or accruals that consist of non-cash
consideration. REG-104259-18, 83 FR 65956, 65960 (December 21, 2018).
Comments have suggested that corporate nonrecognition transactions or
transactions in which U.S. taxpayers do not obtain a step-up in the tax
basis of an acquired asset should not be treated as a base erosion
payment. They argued that these nonrecognition transactions should not
be treated as a payment or accrual. Based on this position, some
comments argued either that the Treasury Department and the IRS do not
have the authority to treat nonrecognition transactions as base erosion
payments or that the better policy is to exclude nonrecognition
transactions from the definition of base erosion payments. Furthermore,
comments argued that nonrecognition provisions such as sections 332,
351, and 368 reflect the judgment of Congress that certain corporate
transactions such as the formation and dissolution of businesses and
the readjustment of continuing interests in property do not warrant the
imposition of tax. They also argued that the legislative history of
section 59A does not suggest that Congress intended for it to apply to
nonrecognition transactions.
With regard to section 332 liquidations, comments argued that a
section 332 liquidation should not be treated as a base erosion payment
when a section 301 distribution is not. Furthermore, comments argued
that transactions in which stock is merely deemed to be exchanged, like
certain section 351 transactions or section 332 liquidations, should
not be treated as base erosion payments since there is no actual
transfer of shares.
Comments also argued that nonrecognition transactions are not base
eroding. Comments asserted that inbound nonrecognition transactions are
often used in post-acquisition restructurings, as well as in other
internal restructurings to better align a multinational organization's
legal structure with its commercial operations. Comments also argued
that treating these transactions as base erosion payments would provide
a disincentive to move intangible property and other income-producing
property into the United States, contrary to the goals of the Act.
Furthermore, comments argued that amortization of a carryover tax
basis of an asset acquired by a U.S. taxpayer from a related party in a
nonrecognition transaction would not create the same base erosion
concerns as other types of deductions. However, comments acknowledged
that, if final regulations adopted a broad exception for nonrecognition
transactions, taxpayers could abuse that exception by engaging in
certain basis step-up transactions immediately before an inbound
nonrecognition transfer. Comments suggested that augmenting the conduit
anti-abuse rule of proposed Sec. 1.59A-9 may be sufficient to prevent
these types of transactions. Alternatively, comments also suggested
that, to delineate cases of potential abuse, a rule similar to the 5-
year active trade or business rules in Sec. 1.355-3 could apply to
specify instances when assets would qualify as not being ``recently
stepped up assets.''
Comments generally supported the statement in the preamble to the
proposed regulations that a section 301 distribution is not treated as
a base erosion payment because there is no exchange, and requested that
the exclusion be included in the final regulations as well as the
preamble. Comments also requested that the definition of a base erosion
payment also exclude exchanges (including section 302 and 304
transactions) that are treated as section 301 distributions pursuant to
section 302(d).
Comments have generally acknowledged that the taxable transfer of
depreciable or amortizable property in exchange for stock should be
subject to the BEAT. For example, comments stated that the transfer of
assets to a corporation that is partially taxable to the transferor
pursuant to section 351(b) or 356 as a result of the receipt of
``boot'' by the transferor is appropriately treated as a base erosion
payment. The amount of the base erosion payment could be determined
based on the gain or increase in basis of the property, the amount of
boot allocated to the property, or by treating all of the boot as paid
for depreciable or amortizable property first, to the extent thereof.
Comments also requested clarity on the treatment of the assumption of
liabilities pursuant to a nonrecognition transaction. One comment
requested that the assumption of liabilities in a nonrecognition
transaction be excluded from the definition of a base erosion payment
to the extent that the assumption is not treated as money or other
property. This comment suggested that, if the Treasury Department and
the IRS are concerned about abusive transactions, an anti-abuse rule
could be designed to treat certain liabilities as base erosion
payments.
Similarly, comments stated that the taxable transfer of assets to a
domestic corporation in exchange for stock, such as in a so-called
``busted section 351 transaction,'' should be subject to the BEAT.
Comments also discussed whether a taxable distribution to a domestic
corporation in a section 331 liquidation of a foreign corporation
should be subject to the BEAT. These comments acknowledged that taxable
transactions generally give rise to base erosion payments and did not
take a view on whether section 331 liquidations should be subject to
the BEAT. Accordingly, comments requested that nonrecognition
transactions be excluded from the definition of a base erosion payment
only to the extent that the U.S. taxpayer obtains a carryover basis in
the acquired asset. Alternatively, comments have requested a safe
harbor that would exclude nonrecognition transactions that are part of
post-acquisition restructuring to allow taxpayers to transfer into the
United States
[[Page 66978]]
intellectual property that was recently acquired from a third party.
Comments have also requested that final regulations clarify that
nonrecognition transactions that occurred before the effective date of
the BEAT will not be treated as base erosion payments.
Finally, comments have noted that a nonrecognition transaction
involving a U.S. branch of a foreign corporation may not qualify for
the ECI exception under proposed Sec. 1.59A-3(b)(3)(iii) for payments
that are treated as effectively connected income in the hands of the
payee, because the ECI exception under proposed Sec. 1.59A-
3(b)(3)(iii) is predicated on the payment or accrual being subject to
U.S. federal income taxation, which cannot occur when the transaction
is not taxable.
Consistent with these comments, the final regulations generally
exclude amounts transferred to, or exchanged with, a foreign related
party in a transaction described in sections 332, 351, and 368
(``corporate nonrecognition transaction'') from the definition of a
base erosion payment. In light of the comments, the Treasury Department
and the IRS have determined a limited exclusion of corporate
nonrecognition transactions is consistent with the underlying anti-base
erosion purpose of the BEAT, tends to reduce disincentives for
taxpayers to move intangible property and other income-producing
property into the United States in corporate nonrecognition treatment
transactions, and is consistent with the general treatment of corporate
nonrecognition transactions under other sections of the Code. However,
the Treasury Department and the IRS have determined that it is not
appropriate to apply this exception to the transfer of other property,
or property transferred in exchange for other property, in a corporate
nonrecognition transaction. Solely for purposes of determining what is
a base erosion payment, ``other property'' has the meaning of other
property or money, as used in sections 351(b), 356(a)(1)(B), and
361(b), as applicable, including liabilities described in section
357(b). However, other property does not include the sum of any money
and the fair market value of any property to which section 361(b)(3)
applies. Other property also includes liabilities that are assumed by
the taxpayer in a corporate nonrecognition transaction, but only to the
extent of the amount of gain recognized under section 357(c).
For example, if a foreign corporation transfers depreciable
property to its wholly owned domestic subsidiary in a transaction to
which section 351 applies, and if the foreign corporation receives
subsidiary common stock and cash in exchange, the cash may be treated
as a base erosion payment, while the common stock is not. Similarly,
property transferred in a section 351 or 368 transaction in exchange,
in whole or in part, for other property may be a base erosion payment
if it otherwise meets the definition of a base erosion payment. For
example, if a domestic corporation transfers property to its wholly-
owned foreign subsidiary in a transaction to which section 351 applies,
and if the domestic corporation receives common stock in the foreign
corporation and other property consisting of depreciable property, the
property transferred by the domestic corporation may be a base erosion
payment. These rules apply without regard to whether or not gain or
loss is recognized in the transaction.
When a taxpayer transfers other property to a foreign related
party, or transfers property to a foreign related party in exchange for
other property, the determination of the amount of property that is
treated as received from the foreign related party in exchange for the
property transferred to the foreign related party is based on U.S.
federal income tax law. See, for example, Rev. Rul. 68-55, 1968-1 C.B.
140.
Consistent with concerns raised by comments, the Treasury
Department and the IRS are concerned that the exclusion of
nonrecognition transactions could lead to inappropriate results in
certain situations. An example of an inappropriate result is the sale
of depreciable property between foreign related parties shortly before
a nonrecognition transaction, which could step up the taxpayer's basis
in the property and increase depreciation or amortization deductions of
the domestic corporation after the nonrecognition transaction relative
to the alternative in which the step-up basis transactions did not
occur. Accordingly, the Treasury Department and the IRS have determined
that it is appropriate to specifically address these transactions with
an anti-abuse rule. See Sec. 1.59A-9(b)(4). The anti-abuse rule
applies in addition to, and in conjunction with, section 357(b). In
addition, the Treasury Department and the IRS observe that, because the
BEAT is applied after the application of general U.S. federal income
tax law, other doctrines--including the step transaction doctrine and
economic substance doctrine--also may apply.
Because the final regulations provide an exception for corporate
nonrecognition transactions, it is not necessary for the final
regulations to include other suggested modifications, such as (i)
modifying the ECI exception for nonrecognition transactions involving
U.S. branches, (ii) providing a safe harbor that would exclude
nonrecognition transactions that are part of a post-acquisition
restructuring, or (iii) clarifying that nonrecognition transactions
that occurred before the effective date of the BEAT are not treated as
base erosion payments.
The final regulations also clarify the treatment of distribution
transactions, such as distributions described in section 301, and
redemption transactions, such as redemptions described in section 302.
A distribution with respect to stock for which there is no
consideration (a ``pure distribution'') is not treated as an exchange.
Accordingly, the final regulations provide that a pure distribution of
property made by a corporation to a shareholder with respect to its
stock is not an amount paid or accrued by the shareholder to the
corporation. These pure distributions include distributions under
section 301, without regard to the application of section 301(c) to the
shareholder (addressing distributions in excess of earnings and
profits). Sec. 1.59A-3(b)(2)(ii). However, unlike a pure distribution,
a redemption of stock in exchange for property constitutes an exchange.
Accordingly, the final regulations provide that a redemption of stock
by a corporation within the meaning of section 317(b) (such as a
redemption described in section 302(a) and (d) or section 306(a)(2)),
or an exchange of stock described in section 304 or section 331, is an
amount paid or accrued by the shareholder to the corporation (or by the
acquiring corporation to the transferor in a section 304 transaction).
4. Interest Expense Allocable to a Foreign Corporation's Effectively
Connected Income
a. In General
Section 59A applies to foreign corporations that have income that
is subject to net income taxation as effectively connected with the
conduct of a trade or business in the United States, taking into
account any applicable income tax treaty of the United States. The
proposed regulations generally provide that a foreign corporation that
has interest expense allocable under section 882(c) to income that is
effectively connected with the conduct of a trade or business within
the United States will have a base erosion payment to the extent the
interest expense results from a payment or accrual to a foreign related
party. The amount of interest that will be treated as
[[Page 66979]]
a base erosion payment depends on the method used under Sec. 1.882-5.
If a foreign corporation uses the three-step method described in
Sec. 1.882-5(b) through (d), the proposed regulations provide that
interest on direct allocations and on U.S.-booked liabilities that is
paid or accrued to a foreign related party will be a base erosion
payment.\1\ See proposed Sec. 1.59A-3(b)(4)(i)(A). If U.S.-booked
liabilities exceed U.S.-connected liabilities, the proposed regulations
provide that a foreign corporation computing its interest expense under
this method must apply the scaling ratio to all of its interest expense
on a pro-rata basis to determine the amount that is a base erosion
payment. The amount of interest on excess U.S.-connected liabilities
that is a base erosion payment is equal to the interest on excess U.S.-
connected liabilities multiplied by the foreign corporation's ratio of
average foreign related-party liabilities over average total
liabilities. See proposed Sec. 1.59A-3(b)(4)(i)(A)(2).
---------------------------------------------------------------------------
\1\ For purposes of Sec. 1.882-5, direct allocations generally
refer to the requirement that a foreign corporation allocate
interest expense to income from particular assets; these
circumstances generally arise with respect to (i) certain assets
that are subject to qualified nonrecourse indebtedness or (ii)
certain assets that are acquired in an integrated financial
transaction.
---------------------------------------------------------------------------
If a foreign corporation determines its interest expense under the
separate currency pools method described in Sec. 1.882-5(e), the
proposed regulations provide that the amount of interest expense that
is a base erosion payment is equal to the sum of (1) the interest
expense on direct allocations paid or accrued to a foreign related
party and (2) the interest expense in each currency pool multiplied by
the ratio of average foreign related-party liabilities over average
total liabilities for that pool. See proposed Sec. 1.59A-
3(b)(4)(i)(B).
Comments requested that a consistent method apply to determine the
portion of interest allocated to a U.S. branch that is treated as paid
to a foreign related party. The comments noted that the methods in the
proposed regulations may produce meaningfully different amounts of base
erosion payments depending on which method the taxpayer uses to
determine its branch interest expense. Comments noted that a branch
that uses the method described in Sec. 1.882-5(b) through (d) may have
a lower amount of base erosion payments than a branch using the method
described in Sec. 1.882-5(e) or a permanent establishment applying a
U.S. tax treaty, although those differences will ultimately depend on
the composition of the counterparties of the U.S.-booked liabilities
and the excess U.S.-connected liabilities (as foreign related parties
or not foreign related parties). See also Part IV.B.5 of this Summary
of Comments and Explanation of Revisions for a discussion of interest
allowed to permanent establishments applying a U.S. tax treaty. The
comments argued that these differences are not supported by tax policy.
Comments generally requested a rule permitting or requiring foreign
corporations to use U.S.-booked liabilities to determine the portion of
U.S. branch interest expense that is treated as paid to foreign related
parties, consistent with the method described in the proposed
regulations for corporations that determine U.S. branch interest
expense using the method described in Sec. 1.882-5(b) through (d),
even if the U.S. branch uses a different method to determine its
interest expense. The comments argued that U.S. assets are used to
determine the amount of leverage that is properly allocable to a U.S.
branch, and, as a result, U.S.-booked liabilities should determine the
amount of interest treated as a base erosion payment. Specifically with
regard to banks, a comment argued that banks are highly regulated with
limited or no ability to manipulate U.S.-booked liabilities, and, as a
result, should be permitted to use U.S.-booked liabilities to determine
the amount of U.S. branch interest expense treated as paid to foreign
related parties.
The Treasury Department and the IRS agree that the rules for
determining the portion of U.S. branch interest paid to foreign related
parties should be consistent, regardless of whether taxpayers apply the
method described in Sec. 1.882-5(b) through (d) or Sec. 1.882-5(e).
For purposes of section 59A, the Treasury Department and the IRS agree
that the starting point for determining the identity of the recipient
should be the U.S. booked liabilities of the U.S. branch. The final
regulations, therefore, provide that the amount of U.S. branch interest
expense treated as paid to a foreign related party is the sum of: (1)
The directly allocated interest expense that is paid or accrued to a
foreign related party, (2) the interest expense on U.S.-booked
liabilities that is paid or accrued to a foreign related party, and (3)
the interest expense on U.S.-connected liabilities in excess of
interest expense on U.S.-booked liabilities multiplied by the ratio of
average foreign related-party interest over average total interest
(excluding from this ratio interest expense on U.S. booked liabilities
and interest expense directly allocated). See Sec. 1.59A-
3(b)(4)(i)(A); see also Part IV.B.4.b.i of this Summary of Comments and
Explanation of Revisions (discussing the change from a worldwide
liability ratio to a worldwide interest ratio). In adopting a
consistent approach, the final regulations use the same ratio to
determine whether the interest expense on U.S.-connected liabilities is
paid to a foreign related party regardless of whether a taxpayer
applies the method described in Sec. 1.882-5(b) through (d) or Sec.
1.882-5(e). See Sec. 1.59A-3(b)(4)(i)(A)(3).
b. Simplifying Conventions
The Treasury Department and the IRS recognize that Sec. 1.882-5
provides certain simplifying elections for determining the interest
deduction of a foreign corporation. The proposed regulations request
comments about similar simplifying elections for determining the
portion of U.S.-connected liabilities that are paid to a foreign
related party for purposes of section 59A. REG-104259-18, 83 FR 65956,
65960 (December 21, 2018).
Comments, in response to the request for comments on simplifying
conventions, indicated that it may be difficult for foreign
corporations to determine their worldwide ratio of liabilities owed to
foreign related parties over total liabilities (``worldwide liabilities
ratio''). For example, they argued that U.S. branches of foreign banks
typically do not have full access to information about the bank's
global operations and funding arrangements. These comments argued that
even if a U.S. branch does have that information, U.S. tax law may
treat some transactions as debt that non-U.S. tax law does not, or may
integrate some hedging costs that are not integrated for non-U.S. tax
purposes, or vice-versa. These comments further observed that if the
taxpayer is using the fixed ratio election for purposes of Sec. 1.882-
5, the taxpayer would not be required to obtain that information or
reconcile the home office balance sheet to U.S. tax law principles for
purposes of Sec. 1.882-5. Thus, the comments argued that attempting to
reconstruct a global balance sheet and payments under U.S. tax
principles for purposes of proposed Sec. 1.59A-3 is burdensome and
should not be required.
The comments also requested various simplifying elections for
determining the amount of U.S. branch interest treated as paid to
foreign related parties, including (a) computing the worldwide ratio by
reference to interest expense rather than worldwide liabilities
(``worldwide interest ratio''), (b) using financial accounting books
and records rather than U.S. tax principles to determine a worldwide
ratio, or (c)
[[Page 66980]]
providing a fixed ratio for purposes of determining the minimum amount
of interest treated as paid to third parties (such as 85 percent).
i. Worldwide Interest Ratio
The final regulations adopt the comment recommending that taxpayers
apply the worldwide ratio to determine the amount of a U.S. branch's
interest expense paid to foreign related parties by reference to a
worldwide ratio of interest expense, rather than a worldwide ratio of
liabilities. See Sec. 1.59A-3(b)(4)(i)(A)(3). The final regulations
adopt this approach as a rule, rather than as an election, because the
Treasury Department and the IRS agree with the comments that a
worldwide ratio based on interest expense, rather than liabilities, is
the appropriate measurement for determining a U.S. branch's base
erosion payments. Section 59A determines the amount of interest that is
a base erosion payment based on the amount of interest paid or accrued
to foreign related parties, rather than the amount of liabilities owed
to foreign related parties. Accordingly, the final regulations
determine the amount of a U.S. branch's interest expense treated as a
base erosion payment based on the foreign corporation's worldwide
interest ratio.
ii. Use of Applicable Financial Statements
The Treasury Department and the IRS recognize that it may be
difficult for foreign corporations to determine their worldwide
interest ratio under U.S. tax principles, as indicated by the comments.
Accordingly, for simplicity and to reduce the administrative burden on
taxpayers, the final regulations adopt the comment to allow taxpayers
to elect to determine their worldwide interest ratio using their
applicable financial statements as described in section 451(b)(3). See
Sec. 1.59A-3(b)(4)(i)(D). The final regulations also clarify that the
applicable financial statement must be the applicable financial
statement of the taxpayer, not a consolidated applicable financial
statement, because a consolidated applicable financial statement may
eliminate inter-company liabilities. The final regulations provide that
a taxpayer makes this election on Form 8991 or a successor form. Until
the Form 8991 is revised to incorporate the election, a taxpayer should
attach a statement with that form to make this election as provided in
forms and instructions.
iii. Fixed Ratio or Safe Harbor for the Worldwide Interest Ratio
The final regulations do not adopt a fixed ratio or safe harbor for
the worldwide interest ratio as suggested in comments because the
actual worldwide interest ratio of an enterprise may vary significantly
from one industry to another and from one taxpayer to another. As a
result, it is not possible to establish a single safe harbor that
appropriately takes into account the differing position of industries
and taxpayers while protecting the interests of the government. The
Treasury Department and the IRS recognize that Sec. 1.882-5 provides
other safe harbors, such as the fixed ratio safe harbor for determining
the ratio of liabilities to assets of 95 percent for banks and 50
percent for other taxpayers. Sec. 1.882-5(c)(4). In the context of
determining the portion of a U.S. branch's interest expense that is
deemed attributed to foreign related parties (versus other persons),
the Treasury Department and the IRS determined that there is not a
sufficient basis to establish a safe harbor because different taxpayers
could have different internal capital structures.
One comment suggested that a U.S. branch of a bank should be
permitted to assume that 85 percent of its funding is from unrelated
lenders because regulations under section 884 provide a safe harbor
assumption that 85 percent of a bank's capital can be deemed to come
from deposits (and thus eligible for the bank deposit interest
exemption from the tax imposed by section 881(a)). See Sec. 1.884-
4(a)(2)(iii). The section 884 safe harbor, however, is not relevant to
the determination of the ratio of funding from foreign related parties
because the bank deposit exception is available for both related and
unrelated depositors/lenders. Thus, this section 884 safe harbor does
not reflect the expected percentage of the lenders who are not foreign
related parties. See section 871(i)(2) and section 881(d).
c. Other Coordinating Rules
The final regulations also revise Sec. 1.59A-3(b)(4)(1) to take
into account the expansion of the exception for certain total loss-
absorbing capacity securities to include foreign issuers. See Part
IV.C.5 of this Summary of Comments and Explanation of Revisions
(Exception for Interest on Certain Instruments Issued by Globally
Systemically Important Banking Organizations).
Finally, a comment recommended that the final regulations revise
proposed Sec. 1.59A-3(b)(4)(i)(D), which provides that to the extent
that a taxpayer makes an election to reduce its U.S.-connected
liabilities pursuant to Sec. 1.884-1(e)(3), the reduction is treated
as proportionally reducing all liabilities for purposes of determining
the amount of allocable interest expense that is treated as a base
erosion payment. The comment argued that Sec. 1.59A-3(b)(4)(i)(D) is
inconsistent with Sec. 1.884-1(e)(3), which applies for all purposes
of the Code, and which the comment asserted does not require
proportionate reduction. In response to this comment, the final
regulations do not include the rule in proposed Sec. 1.59A-
3(b)(4)(i)(D). The Treasury Department and the IRS are considering
Sec. 1.884-1(e)(3) for possible future guidance.
5. Allocations of Interest and Other Expenses Pursuant to Income Tax
Treaties
The proposed regulations provide a specific rule for determining
the amount of base erosion payments attributable to interest and
deductions allocated to a permanent establishment under a U.S. income
tax treaty. Certain U.S. income tax treaties provide alternative
approaches for the allocation or attribution of business profits of an
enterprise of one contracting state to its permanent establishment in
the other contracting state on the basis of assets used, risks assumed,
and functions performed by the permanent establishment. These treaties
allow notional payments that take into account interbranch transactions
and value the interbranch transactions using the most appropriate arm's
length method for those transactions. A treaty-based expense allocation
or attribution method does not itself create legal obligations between
the U.S. permanent establishment and the rest of the enterprise. The
proposed regulations reflect that under a treaty-based expense
allocation or attribution method, amounts equivalent to deductible
payments may be allowed in computing the business profits of an
enterprise with respect to transactions between the permanent
establishment and the home office or other branches of the foreign
corporation (``internal dealings''). The deductions from internal
dealings would not be allowed under the Code and regulations. The
proposed regulations provide that deductions from internal dealings
allowed in computing the business profits of the permanent
establishment are base erosion payments.
The proposed regulations distinguish between the allocations of
expenses and internal dealings. The allocation and apportionment of
expenses of the
[[Page 66981]]
enterprise to the branch or permanent establishment is not a base
erosion payment because the allocation represents a division of the
expenses of the enterprise, rather than a payment between the branch or
permanent establishment and the rest of the enterprise. Internal
dealings, however, are not mere divisions of enterprise expenses;
rather, internal dealings are priced on the basis of assets used, risks
assumed, and functions performed by the permanent establishment in a
manner consistent with the arm's length principle. The proposed
regulations create parity between deductions for actual regarded
payments between two separate corporations (which are subject to
section 482), and internal dealings (which are generally priced in a
manner consistent with the applicable treaty and, if applicable, the
OECD Transfer Pricing Guidelines). The proposed regulations apply only
to deductions attributable to internal dealings, and not to payments to
entities outside of the enterprise, which are subject to the general
base erosion payment rules as provided in proposed Sec. 1.59A-
3(b)(4)(v)(A).
Comments noted that internal dealings are a fiction and do not
involve an actual payment or accrual under general U.S. tax principles.
The comments suggested that internal dealings should be relevant only
for purposes of determining the profit attributable to the permanent
establishment and should not be recognized for other purposes. They
noted that the OECD 2010 Report on the Attribution to Profits to
Permanent Establishments (``2010 OECD Report'') states that recognizing
internal dealings by a permanent establishment ``is relevant only for
the attribution of profits'' and ``does not carry wider implications as
regards, for example, withholding taxes.'' 2010 OECD Report (July 22,
2010), Part IV, C-1(iii)(f), section 166. Thus, comments suggested that
internal dealings should not be relevant for BEAT purposes.
The Treasury Department and the IRS disagree that internal dealings
are not relevant for purposes of determining a foreign corporation's
base erosion payments. Unlike the allocation of a foreign corporation's
deductions to a U.S. branch under the Code and regulations, internal
dealings are not a mere allocation of expenses, but rather are
determined on the basis of assets used, risks assumed, and functions
performed by the permanent establishment in a manner consistent with
the arm's length principle. Deductions determined under internal
dealings, like deductions determined under the Code and regulations,
reduce the U.S. income tax base of the permanent establishment. Because
internal dealings are not an allocation of expenses, the foreign
corporation's worldwide ratio may not be an appropriate measure of
related party payments. Instead, in the proposed regulations, the
Treasury Department and the IRS determined that it is appropriate to
look to the internal dealings, rather than the foreign corporation's
worldwide expenses, for purposes of determining base erosion payments.
However, the Treasury Department and the IRS recognize that
interest expense allowed to a permanent establishment as internal
dealings often represents interest expense on back-to-back loans
between (1) the permanent establishment and the home office, and (2)
the home office and another entity. Furthermore, unlike other
deductions that are often based on payments to the home office or to
another branch for goods or services or the use of intellectual
property unique to the home office or branch, money is fungible. A
permanent establishment may be indifferent to whether its capital comes
from the home office or a loan from another entity.
The Treasury Department and the IRS have determined that interest
expense determined under Sec. 1.882-5 generally provides a reasonable
estimate of the amount of interest of the foreign corporation that
should be allocated to the permanent establishment based on the assets
of the permanent establishment. Accordingly, it is appropriate to treat
interest expense determined in accordance with a U.S. tax treaty
(including interest expense determined by internal dealings) in a
manner consistent with the treatment of interest expense determined
under Sec. 1.882-5, to the extent it would have been allocated to the
permanent establishment under Sec. 1.882-5. In effect, the internal
dealing permits the permanent establishment to replace an external
borrowing with an internal dealing, and this internal dealing should be
treated as creating additional interest expense paid to the home
office, and thus treated as a base erosion payment to a foreign payee.
Accordingly, interest expense determined in accordance with a U.S. tax
treaty (including interest expense determined by internal dealings)
that is in excess of the amount that would have been allocated to the
permanent establishment under Sec. 1.882-5 is treated as interest
expense paid by the permanent establishment to the home office or
another branch of the foreign corporation.
Specifically, the final regulations treat interest expense
determined in accordance with a U.S. tax treaty (including interest
expense determined by internal dealings) in a manner consistent with
the treatment of interest expense determined under Sec. 1.882-5, to
the extent of the hypothetical amount of interest expense that would
have been allocated to the permanent establishment under Sec. 1.882-5
(the ``hypothetical Sec. 1.882-5 interest expense''). For purposes of
this calculation, the hypothetical Sec. 1.882-5 interest expense
cannot exceed the amount of interest expense determined under the U.S.
tax treaty. Interest expense in excess of the hypothetical Sec. 1.882-
5 interest expense is treated as interest expense paid by the permanent
establishment to the home office or another branch of the foreign
corporation, and therefore is treated as a base erosion payment. See
Sec. 1.59A-3(b)(4)(i)(E).
Accordingly, under the final regulations, a foreign corporation
determines its hypothetical Sec. 1.882-5 interest expense by
calculating the amount of interest that would have been allocated to
effectively connected income if the foreign corporation determined its
interest expense under Sec. 1.882-5. See Sec. 1.59A-3(b)(4)(i)(E)(2).
Therefore, a foreign corporation will use the method provided in Sec.
1.59A-3(b)(4)(i)(A), as described in Part IV.B.4.a in this Summary of
Comments and Explanation of Provisions, to determine its hypothetical
Sec. 1.882-5 interest expense.
In this regard, the Treasury Department and the IRS observe that
corporations eligible for benefits under a U.S. income tax treaty are
permitted to choose whether to apply the treaty or the Code and
regulations to calculate interest expense allocable to a permanent
establishment or U.S. branch, and understand that many corporations
eligible for treaty benefits calculate interest expense allocated to a
U.S. branch or permanent establishment under both Sec. 1.882-5 and the
applicable treaty to determine whether to claim treaty benefits.
Additionally, the Treasury Department and the IRS also understand that
corporations that determine interest expense allowed to a permanent
establishment under a U.S. income tax treaty may nonetheless be
required to allocate interest to the permanent establishment under
Sec. 1.882-5 for state or local tax purposes.
6. Related-Party Hedging Payments
Comments requested that the final regulations provide relief from
the application of the BEAT for hedging
[[Page 66982]]
payments made by domestic corporations to foreign related parties,
specifically in the context of the energy industry. The comments
described a scenario in the energy industry where large multinational
groups designate one or more members of their worldwide group to act as
a hedging center to manage price risk associated with commodities that
the group produces or sells through the execution of commodities
derivatives. The comments indicated that under prevailing industry
practice and applicable financial accounting standards, income, gain,
loss, or expense on commodity derivatives are often accounted for as
items of COGS or as a reduction to determine gross income for book
accounting purposes. These items, however, are not treated as COGS or
as another form of reduction to determine gross income for tax
purposes; the items are deductions for tax purposes and potentially
within the scope of section 59A(d)(1) and proposed Sec. 1.59A-
3(b)(1)(i). The payments described in these comments are not eligible
for the QDP exception in section 59A(h) and proposed Sec. 1.59A-6. The
comments requested that the final regulations include a rule that
related-party hedging payments are not base erosion payments.
The final regulations do not adopt this recommendation. The status
of an item as a deduction is determined under U.S. federal income tax
law, not industry practice or financial accounting treatment. Although
the legislative history of section 59A states that base erosion
payments do not include any amount that constitutes reductions to
determine gross income, including payments for COGS, these statements
are in the context of U.S. federal income tax law, which sets forth the
tax law for deductions. In addition, section 59A(d)(1) refers to
``deductions allowable under this chapter,'' that is, chapter 1 (normal
taxes and surtaxes) of Subtitle A (income taxes) of the Code, which
includes section 1 through section 1440Z-2. Congress did not indicate
that the definition of a reduction to determine gross income or COGS
for purposes of section 59A should be derived from financial accounting
principles. In the absence of clear Congressional intent otherwise, the
Treasury Department and the IRS believe that whether an amount
constitutes a reduction to determine gross income or COGS must be
determined under established principles of U.S. federal income tax law.
Consequently, if related-party hedging payments are not properly
treated as reductions to determine gross income for tax purposes, these
payments are not excluded from the definition of base erosion payments.
See also Part IV.A.3.b of this Summary of Comments and Explanation of
Revisions (Netting of income and expense; Hedging transactions).
7. Captive Finance Subsidiaries
Comments addressed the impact of the BEAT on domestic corporate
captive finance subsidiaries that purchase property (business
equipment) from a foreign related party and then lease the property to
unrelated third party end users. The comments requested that the final
regulations permit taxpayers using this type of business model to treat
the depreciation deductions attributable to the leased property as COGS
for purposes of the BEAT. The comments premised this requested
treatment on the theory that the cost of the leased property and its
associated depreciation deductions are directly correlated with the
rental income generated from leasing the property and on the unique
nature of this particular business model.
The final regulations do not include an exception from the
definition of base erosion payments for the transactions described in
these comments. Under section 59A(d)(2), the deduction allowed for
depreciation with respect to property acquired from a foreign related
party is a base erosion tax benefit, notwithstanding that the property
acquired by the taxpayer is used in an income-generating business in
the United States, such as the leasing of the business equipment to
unrelated third party lessees of the property or operating the business
equipment itself as a service for unrelated third parties.
8. Capitalization and Amortization of Research and Experimental
Expenditures
One comment recommended that the final regulations clarify the
treatment of research and experimental (``R&E'') expenditures after
such costs are required to be amortized in taxable years beginning
after December 31, 2021, under section 174. The comment recommended
clarification that after the change to section 174 is in effect, the
BEAT payment associated with R&E expenses is limited to the amount of
amortization. The final regulations do not adopt this comment because
the Treasury Department and the IRS view Sec. 1.59A-3(b)(1)(i) and
Sec. 1.59A-3(c)(1)(i) as sufficiently clear in setting forth that a
base erosion payment to a foreign related party does not result in a
base erosion tax benefit until the deduction is ``allowed under chapter
1 of subtitle A of the [Code].''
C. Other Exceptions From the Base Erosion Payment Definition Contained
in the Proposed Regulations
1. Exception for Certain Amounts With Respect to Services and the
Services Cost Method
Proposed Sec. 1.59A-3(b)(3)(i) provides that a base erosion
payment does not result from amounts paid or accrued to a foreign
related party for services that are eligible for the SCM exception
described in proposed Sec. 1.59A-3(b)(3)(i)(B), but only to the extent
of the total services cost of those services. Any amount paid or
accrued to a foreign related party in excess of the total services cost
of services eligible for the SCM exception (the mark-up component)
remains a base erosion payment. Proposed Sec. 1.59A-3(b)(3)(i)(B)
provides that the SCM exception applies if all of the requirements of
Sec. 1.482-9(b), which describes the SCM, are satisfied, with two
exceptions. First, the requirements of Sec. 1.482-9(b)(5), commonly
referred to as the business judgment rule, do not apply. Second, the
books and records requirement described in Sec. 1.482-9(b)(6) is
replaced with the requirements of proposed Sec. 1.59A-3(b)(3)(i)(C).
Section 1.482-9(b)(4) provides that certain activities, including
research, development, and experimentation, are not eligible for the
SCM. As a result, payments for these services do not qualify for the
SCM exception described in proposed Sec. 1.59A-3(b)(3)(i)(B).
Comments supported the SCM exception and recommended that final
regulations adopt this approach. The final regulations continue to
provide that the SCM exception is available for the cost portion of a
payment that otherwise meets the requirements for the SCM exception. A
comment recommended that the final regulations provide examples or
clarification as to the requirement in proposed Sec. 1.59A-
3(b)(3)(i)(C) that taxpayers' books and records provide sufficient
documentation to allow verification of the methods used to allocate and
apportion the costs to the services in question in accordance with
Sec. 1.482-9(k). The final regulations include additional detail on
the documentation required to satisfy this requirement. Sec. 1.59A-
3(b)(3)(i)(C).
Comments also recommended that the final regulations extend the SCM
exception to the cost element of payments for other types of services
that are not eligible for the SCM. Some comments suggested that an
exception
[[Page 66983]]
should be available for all services. Some comments suggested that an
exception should be available for services that are excluded under
Sec. 1.482-9(b)(4) (excluded activities) but that otherwise would be
eligible for the SCM exception described in proposed Sec. 1.59A-
3(b)(3)(i)(B). Some comments suggested that an exception should be
available for research and experimentation services.
Comments suggested that applying the SCM exception to only some
services will lead to inequitable results for services companies as
compared to similarly situated U.S. manufacturers and distributors
because the definition of base erosion payments does not include
payments included in COGS, but there is not a similar rule for the
costs in a services business. Comments also claimed that, relative to
manufacturers or distributors, service companies are more constrained
in where they operate. Comments also asserted that no base erosion
could result from an expansion of the SCM exception because only the
cost element of the service fee would be subject to the exception.
The comments suggesting that an exception should be available for
excluded activities that otherwise would be eligible for the SCM also
asserted that the list of excluded activities serves a similar purpose
as the business judgment rule, which is to identify services for which
total services costs can constitute an inappropriate reference point
for determining profitability or that should be subject to a more
robust transfer pricing analysis. Comments suggested that Sec. 1.482-
9(b)(4) is essentially a list of specific activities for which the SCM
is unavailable because they are deemed to contribute significantly to
key competitive advantages, core capabilities, or fundamental risks of
success or failure of the business. These comments suggested that when
section 59A(d) states that the exception therein is based on compliance
with the services cost exception in section 482 ``(determined without
regard to the requirement that the services not contribute
significantly to fundamental risks of business success or failure)'',
that language was intended to disregard the list of excluded
activities.
The comments requesting an expansion of the SCM exception for
research and experimentation services also asserted that extending the
SCM exception to these services would reduce the incentive to move
intangible property offshore and would broaden the U.S. tax base by
encouraging U.S. ownership and exploitation of newly created intangible
property.
Section 59A(d)(5)(A) sets forth the parameters under which certain
services--those that are eligible for the SCM without regard to the
business judgment rule--are eligible for the SCM exception. The
Treasury Department and IRS have considered the policy considerations
that the comments raised for expanding the SCM exception, but have
determined that the recommendation to expand the SCM exception is
inconsistent with the parameters that Congress set forth in section
59A(d)(5). Further, the Treasury Department and IRS disagree with the
premise in the comments that the list of excluded activities serves the
same purpose as the business judgment rule. While certain services that
are ineligible for the SCM as a result of being on the list of excluded
activities also may be ineligible for the SCM as a result of failing
the business judgment rule, the list of excluded activities from the
SCM provides an objective list of categories that tend to be high
margin or for which the cost of the services tends to be an
inappropriate reference point for the price of those services. See 71
FR 44466, 44467-68 (Aug. 4, 2006). By contrast, the business judgment
rule also excludes from the SCM services that tend to be low margin as
a general matter, but in the context of a particular business are a
core competency of the business. See 71 FR 44466, 44467 (Aug. 4, 2006).
The parenthetical language in section 59A(d)(5)(A) indicates
unambiguously that Congress intended the SCM exception to be available
for all services that are typically low margin even if, in the context
of a particular business, the service is a core competency of a
business that may not satisfy the criteria in Sec. 1.482-9(b)(5).
Accordingly, the Treasury Department and the IRS have determined that
the SCM exception should continue to follow the statute, and the rule
is unchanged from the proposed regulations.
2. Qualified Derivatives Payments
For a discussion of QDPs, see Part VII of this Summary of Comments
and Explanation of Revisions.
3. Exception to Base Erosion Payment Status for Payments the Recipient
of Which Is Subject to U.S. Tax
Proposed Sec. 1.59A-3(b)(3)(iii) generally provides that a base
erosion payment does not result from amounts paid or accrued to a
foreign related party that are subject to tax as income effectively
connected with the conduct of a trade or business in the United States
(ECI). Comments recommended that final regulations adopt this rule.
Accordingly, this rule is unchanged in the final regulations.
Several comments recommended that final regulations include a
similar exception from the definition of a base erosion payment for
payments made by a domestic corporation to a controlled foreign
corporation (CFC) that result in a subpart F or global intangible low
tax income (GILTI) inclusion. Another comment requested that this
exception be extended to apply to payments made to a passive foreign
investment company (PFIC) when a U.S. person has made a qualified
electing fund (QEF) election, and the payment is included in the
electing U.S. person's gross income. The comments asserted that
payments that give rise to a subpart F or GILTI inclusion do not erode
the U.S. tax base, and accordingly, warrant a base erosion payment
exception under the same policy rationale for granting this type of
exception in the proposed regulations for ECI, section 988 losses, and
interest paid with respect to total loss-absorbing capacity (TLAC)
securities. Finally, comments noted that proposed regulations under
section 267A provide an exception for certain payments that result in
income inclusions under section 951 and section 951A and suggested
equivalent treatment was justified in the case of the BEAT.
The final regulations do not include a subpart F, GILTI, or PFIC
exception to base erosion payment status. The Treasury Department and
the IRS have determined that the reasons for adopting the other
exceptions cited in the comments (such as the ECI exception and the
exception under section 267A) do not warrant a subpart F, GILTI, or QEF
exception from base erosion payment status.
First, comments have misinterpreted the underlying policy rationale
for providing an ECI exception in the proposed regulations. The
proposed regulations' ECI exception was adopted in part based upon the
determination that it would be appropriate in defining a base erosion
payment to consider the U.S. federal tax treatment of the foreign
recipient--particularly, whether a payment received by a foreign
related party was subject to tax on a net basis in substantially the
same manner as amounts paid to a U.S. person. In contrast to the tax
directly imposed on a foreign person with respect to its ECI under
sections 871(b) and 882(a), a CFC receiving a base erosion payment is
not directly subject to U.S. taxation. Rather, the U.S. shareholder is
subject to tax under the subpart F or GILTI regime (or the PFIC rules).
Thus, the CFC recipient
[[Page 66984]]
(or PFIC recipient) of a payment is not itself subject to tax on a net
basis in substantially the same manner as a U.S. person.
In addition, a foreign corporation that is engaged in a U.S. trade
or business is itself subject to section 59A. In contrast, because
neither a CFC nor a PFIC is subject to section 59A, the CFC or PFIC can
make payments to a foreign related party without any BEAT consequences.
The ECI exception was also adopted to achieve symmetry with
proposed Sec. 1.59A-2(c), which treats foreign corporations as outside
of the controlled group, except to the extent that the foreign
corporation has ECI. Because foreign corporations with ECI are treated
as part of the aggregate group in determining whether a taxpayer will
ultimately be subject to the BEAT, the ECI exception to base erosion
payment status is necessary to ensure that the foreign corporation is
treated equivalently to a domestic member of its aggregate group
receiving deductible payments.
The Treasury Department and the IRS further disagree with the
premise that the approaches in the proposed regulations with respect to
TLAC interest and section 988 losses support an exception for subpart F
or GILTI income in the final regulations. With respect to TLAC, the
preamble to the proposed regulations notes that the TLAC exception is
appropriate because of the special status of TLAC as part of a global
system to address bank solvency and the precise limits that regulations
place on the terms of TLAC securities. REG-104259-18, 83 FR 65956,
65963 (December 21, 2018).
With respect to section 988, the preamble to the proposed
regulations states that the exception is based on a determination that
the losses did not present the same base erosion concerns as other
types of losses that arise in connection with payments to a foreign
related party. See REG-104259-18, 83 FR 65956, 65963 (December 21,
2018).
The Treasury Department and the IRS also disagree with the premise
that the approach in the proposed hybrid regulations under section 267A
provides support for a regulatory exception. Section 267A(b)(1)
expressly provides that the disqualified related-party amount does not
include any payment to the extent that the payment is included in the
gross income of a United States shareholder under section 951(a).
Whereas Congress expressly provided an exception for subpart F in
section 267A, Congress did not provide a similar exception for purposes
of section 59A. The Treasury Department and the IRS have determined
that the inclusion of a similar exception in another section of the
Act, but not in section 59A, reflects Congressional intent to not
provide a GILTI or subpart F exception for purposes of section 59A. In
addition, section 59A(c)(4)(B) provides that a deduction under section
250 (providing a domestic corporation a deduction for a portion of its
GILTI amount) is not included in the denominator for purposes of the
base erosion percentage; this shows that Congress considered the
interaction between section 59A and GILTI, but did not provide an
exception from the term base erosion payment for payments subject to
tax under section 951A.
Finally, with respect to the suggested GILTI exception, the
Treasury Department and the IRS are concerned that a GILTI exception
would be difficult to administer because it would require a
determination of whether a particular payment to a CFC is included in
the taxpayer's GILTI inclusion, but a taxpayer's GILTI inclusion often
cannot be traced to particular payments to a CFC because a taxpayer's
GILTI inclusion amount depends on multiple factors. A GILTI exception
would also need to take into account differences in effective and
marginal tax rates under GILTI, BEAT, and regular corporate income tax.
For the foregoing reasons, the final regulations do not provide a
regulatory exception to the definition of a base erosion payment for a
payment that may give rise to subpart F, GILTI, or PFIC inclusions.
4. Exchange Loss From a Section 988 Transaction
Proposed Sec. 1.59A-3(b)(3)(iv) provides that exchange losses from
section 988 transactions described in Sec. 1.988-1(a)(1) are excluded
from the definition of base erosion payments. Proposed Sec. 1.59A-
2(e)(3)(ii)(D) provides that an exchange loss from a section 988
transaction (including with respect to transactions with persons other
than foreign related parties) is not included in the denominator when
calculating the base erosion percentage. The preamble to the proposed
regulations requests comments on whether the denominator should exclude
only section 988 losses with respect to foreign related-party
transactions. REG-104259-18, 83 FR 65956, 65963 (December 21, 2018).
Comments recommended that section 988 losses should not be excluded
from the denominator of the base erosion percentage because excluding
all section 988 losses is not consistent with the statute. Some
comments, however, recommended that section 988 losses with respect to
transactions with foreign related parties that are also excluded from
the numerator should continue to be excluded from the denominator, and
that this approach would be symmetrical with the approach in the
statute for deductions for qualified derivative payments and for
amounts eligible for the SCM exception. The final regulations adopt
this recommendation. See Sec. 1.59A-2(e)(3)(ii)(D). This approach is
also consistent with the treatment of amounts paid to foreign related
parties with respect to TLAC securities, which are excluded from the
denominator only if the deductions arise from foreign related-party
transactions.
5. Exception for Interest on Certain Instruments Issued by Globally
Systemically Important Banking Organizations (GSIBs)
Proposed Sec. 1.59A-3(b)(3)(v) provides that the amount paid or
accrued to a foreign related party with respect to total loss-absorbing
capacity (``TLAC'') securities is not a base erosion payment, but only
to the extent of the amount of TLAC securities required by the Board of
Governors of the Federal Reserve (Federal Reserve Board) under subpart
P of 12 CFR part 252. See proposed Sec. 1.59A-1(b)(18) and (20).
Specifically, proposed Sec. 1.59A-3(b)(3)(v) provides that the amount
excluded is no greater than the amount paid to foreign related parties
multiplied by the scaling ratio, which is the average TLAC long-term
debt required over the average TLAC security amount. The preamble to
the proposed regulations requests comments regarding whether the TLAC
exception should also apply to similar instruments issued by foreign
corporations that are required by law to issue a similar type of loss-
absorbing instruments. These instruments issued by foreign corporations
would be relevant for section 59A if interest expense from those
instruments is deducted by the U.S. branch or permanent establishment
of the foreign corporation. Comments generally supported the exception
for amounts paid to a foreign related party with respect to TLAC and
suggested that the final regulations expand the exception to foreign
issuers.
a. TLAC Issued in Compliance With Foreign Law
Comments requested that the TLAC exception be expanded to include
TLAC issued to comply with foreign laws and regulations that are
similar to the TLAC requirements prescribed by the Federal Reserve
Board. One comment observed that an exception for interest on TLAC that
is issued to comply with foreign
[[Page 66985]]
law and allocated to a U.S. branch or permanent establishment would
provide branch parity, by excluding interest from base erosion payment
status to the same extent, whether that internal TLAC debt is issued by
a U.S. subsidiary or branch. See generally Rev. Proc. 2017-12, 2017-3
I.R.B. 424, for the definition of internal TLAC.
The Treasury Department and the IRS generally agree with comments
that the special status of TLAC as part of the global system to address
bank solvency applies equally to TLAC securities whether issued
pursuant to U.S. law or foreign law. Consistent with comments, the
final regulations expand the scope of the TLAC exception to include
internal securities issued by GSIBs pursuant to laws of a foreign
country that are comparable to the rules established by the Federal
Reserve Board (``foreign TLAC''), where those securities are properly
treated as indebtedness for U.S. federal income tax purposes.\2\ In
order to provide consistency between interest deductions on TLAC of a
domestic subsidiary and a U.S. branch or permanent establishment, the
final regulations limit the foreign TLAC exception to interest expense
of GSIBs, and determine the limitation on the exception by reference to
the specified minimum amount of TLAC debt that would be required
pursuant to rules established by the Federal Reserve Board for TLAC if
the branch or permanent establishment were a domestic subsidiary that
is subject to Federal Reserve Board requirements. In addition, to
ensure that the limitation is not greater than the amount required
under foreign law, the final regulations express the limitation as the
lesser of the hypothetical Federal Reserve Board limitation described
in the preceding sentence and the specified minimum amount of TLAC debt
that is required pursuant to bank regulatory requirements of a foreign
country that are comparable to the requirements established by the
Federal Reserve Board. Further, the Treasury Department and the IRS
understand that in some jurisdictions, foreign TLAC may apply in a more
discretionary manner than the framework established in the proposed
regulations that references the specified minimum amount of TLAC debt
that is required pursuant to rules established by the Federal Reserve
Board for TLAC of U.S. issuers, for example, with no specified minimum
amount. For that reason, if the bank regulatory requirements of a
foreign country do not specify a minimum amount, the limitation is
determined by reference solely to the hypothetical Federal Reserve
Board limitation. The second prong serves to provide general
consistency with TLAC of a domestic subsidiary, by limiting the foreign
TLAC exception to no more than the amount of TLAC that would be
required by the Federal Reserve Board if the branch were a subsidiary
(subject to the modification for a buffer that is also discussed in
this Part IV.C.5.b). These rules tend to support the systemic bank
solvency goals of TLAC by reducing the tax cost of issuing such
securities via foreign related parties. The Treasury Department and the
IRS understand that information necessary to determine this amount is
generally knowable to banks with U.S. operations. The Treasury
Department and the IRS also understand that in some foreign
jurisdictions, the foreign TLAC requirements may apply to organizations
other than GSIBs; however, to provide general consistency with interest
deductions on TLAC of a domestic subsidiary, the final regulations
limit the foreign TLAC exception to only GSIBs.
---------------------------------------------------------------------------
\2\ While final regulations adopt the comment recommending
similar treatment as between TLAC that is required under Federal
Reserve Board regulations and similar foreign TLAC instruments, the
final regulations do not address, and provide no inference, on
whether those instruments issued pursuant to foreign law are treated
as debt for U.S. federal income tax purposes. See Rev. Proc. 2017-
12, 2017-3 I.R.B. 424 (providing generally that the IRS will treat
as indebtedness internal TLAC that is issued by an intermediate
holding company of a foreign GSIB pursuant to the Federal Reserve
Board regulations, and that ``[n]o inference should be drawn about
the federal tax characterization of an instrument that is outside
the scope of [Rev. Proc. 2017-12].'').
---------------------------------------------------------------------------
b. Buffer Amount Above Specified Minimum Amount
Comments also recommended that the final regulations increase the
specified minimum amount of interest eligible for the TLAC exception to
permit an additional ``buffer'' amount of TLAC that exceeds the minimum
amount required to satisfy regulatory requirements (such as 115 percent
of the specified minimum amount or a buffer equal to 1 to 1.5 percent
of the risk-weighted assets). Comments explained that the inputs used
to determine the minimum amount of TLAC needed to satisfy regulatory
requirements change on a daily basis; as a result, the amount of TLAC
securities needed also may change on a daily basis. The comments also
noted that market issues dictate a certain lead time to issue TLAC
securities. As a result, comments stated that it is the market
expectation and practice that GSIBs operate with a buffer, which helps
to ensure that TLAC does not fall below the minimum amount when risk-
weighted assets or total leverage increase. Finally, the comments
asserted that because the cost of issuing TLAC securities significantly
exceeds the cost of issuing non-loss absorbing securities, banks are
commercially incentivized to issue no more TLAC securities than
necessary.
Because of the special status of TLAC as part of a global system to
address bank solvency and the specific requirements established by the
Board and other regulators, the Treasury Department and the IRS
recognize that it is necessary and appropriate to take into account the
market practices that have been adopted to prevent TLAC from falling
below the specified minimum amount as required by regulations. For
these reasons, the final regulations adopt the recommendation to
provide a 15 percent buffer on the specified minimum amount of interest
eligible for the exception. This buffer applies for both TLAC and
foreign TLAC.
c. Requests To Extend the TLAC Exception To Include Other Regulatory
Capital Requirements
The Treasury Department and the IRS decline to expand the TLAC
exception to cover interest payments on debt to foreign related parties
that may satisfy regulatory capital requirements other than TLAC. The
TLAC exception was adopted because of the unique role of TLAC
securities in the global banking system for GSIBs; while other
regulatory capital requirements may also serve an important role in
bank regulation, the Treasury Department and the IRS are cognizant that
the BEAT applies as a general matter to interest paid to foreign
related parties, and have thus limited this regulatory exception to
only those specific securities that are issued as part of the
integrated international financial regulation and supervision system.
d. TLAC Issued During Transition Period
Comments recommended that the final regulations increase the
specified minimum amount of interest eligible for the TLAC exception to
permit interest with respect to TLAC debt in place during a three-year
transition period before the year in which a corporation is required to
have issued TLAC. The final regulations do not extend the TLAC
exception to cover TLAC issued during a pre-effective date or
transition period before being required to comply with the regulations
prescribed by the Federal Reserve Board, because in that situation all
of the debt is discretionary rather than mandatory. Further, there is
no clear objective metric to scope discretionary issuances during a
pre-effective period.
[[Page 66986]]
e. Other Operational Elements of the TLAC Exception
A comment recommended modifying the limitation on the exclusion for
internal TLAC when a portion of the internal TLAC is held by the U.S.
branch of a foreign person such that interest payments on the internal
TLAC is also eligible for the ECI exception. The comment recommended
that interest on the internal TLAC be first attributed to TLAC held by
the U.S. branch of a foreign person, and thus excluded from the
definition of a base erosion payment on the basis of the interest being
ECI; and then only the incremental interest expense in excess of the
amount payable to that branch would be subject to the TLAC scaling
ratio limitation. The final regulations do not further expand the TLAC
exception through such a rule, so as to retain the narrow scope of the
TLAC exception to those securities that are required to be in place
because of Federal Reserve Board requirements (taking into account the
buffer described in this Part IV.C.5.b). The final regulations clarify
the definition of TLAC securities amount to confirm that the TLAC
scaling ratio applies without regard to whether TLAC interest is also
eligible for another exclusion from base erosion payment status, and
thus that the TLAC scaling ratio applies pro-rata to all internal TLAC.
See Sec. 1.59A-1(b)(19).
Another comment recommended that the final regulations modify the
definition of the ``TLAC long term debt minimum amount'' to reflect
international standards, rather than Federal Reserve Board requirements
because the comment asserted that the Federal Reserve Board may, in the
future, eliminate the minimum requirement in the Federal Reserve Board
regulations. Comments also recommended expanding the TLAC exception to
apply to other intercompany debt that is issued to comply with other
bank regulatory capital requirements. The Treasury Department and the
IRS have determined that it is appropriate to limit the amount of the
TLAC exception by reference to Federal Reserve Board requirements,
notwithstanding comments suggesting that in the future the Federal
Reserve Board may eliminate its minimum required amount. If there are
meaningful changes in the total loss absorbing capacity systems in the
future, the Treasury Department and the IRS would be able to reassess
the section 59A regulations.
Finally, a comment recommended that the final regulations should
not exclude interest on TLAC borrowing from the denominator of the base
erosion percentage calculation, which is discussed in Part III of this
Summary of Comments and Explanation of Revisions. The proposed
regulations exclude from the denominator of the base erosion percentage
amounts excluded under certain of the specific exceptions to base
erosion payment status in Sec. 1.59A-3(b) for SCM, QDP, and TLAC. This
is in contrast to those amounts that are not base erosion payments
because they are not within the main definition of a base erosion
payment, for example, a payment to an unrelated third party, which
remain in the denominator. The comment suggested that interest expense
that is excluded from the definition of a base erosion payment under
the TLAC exception should be viewed as like a payment to an unrelated
third party, that is, the interest expense should remain in the
denominator of the base erosion percentage. The comment premised this
position on the view that internal TLAC should be viewed as issued to
the holders of external TLAC (that is, to unrelated third party
investors) under a theory that the issuer of internal TLAC is an
intermediary or conduit for the issuer of the external TLAC securities.
Therefore, there would be no underlying base erosion payment by the
U.S. borrower on the internal TLAC, and thus the internal TLAC interest
expense would remain in the denominator of the base erosion percentage
calculation like interest paid to unrelated third parties. The proposed
regulations and the final regulations provide a regulatory exception
for internal TLAC on the basis of the special status of TLAC issued by
GSIBs as part of the global system to address bank solvency. That is,
the rationale for the TLAC exception in the proposed regulations and
final regulations is not that the internal TLAC is a conduit for the
external TLAC. For this reason, the final regulations (consistent with
the proposed regulations) exclude from the denominator the TLAC
interest in a manner consistent with the treatment of deductions
covered by the SCM and QDP exceptions.
D. Base Erosion Tax Benefits
1. Withholding Tax on Payments
The proposed regulations provide that if tax is imposed by section
871 or 881, and the tax is deducted and withheld under section 1441 or
1442 without reduction by an applicable income tax treaty on a base
erosion payment, the base erosion payment is treated as having a base
erosion tax benefit of zero for purposes of calculating a taxpayer's
modified taxable income and base erosion percentage. If an income tax
treaty reduces the amount of withholding imposed on the base erosion
payment, the amount of the base erosion payment that is treated as a
base erosion tax benefit is reduced in proportion to the reduction in
withholding. In the regulation section pertaining to base erosion tax
benefits, the final regulations include a technical correction to the
fraction used to determine the amount of a base erosion payment that is
treated as a base erosion tax benefit when the rate of withholding
imposed on that payment is reduced by an income tax treaty. Sec.
1.59A-3(c)(3)(i). To avoid duplication, the final regulation section
pertaining to the base erosion percentage replaces a similar operating
rule with a cross reference to the rule for determining base erosion
tax benefits. See Sec. 1.59A-2(e)(3)(iii).
Under section 884(f) and Sec. 1.884-4, a portion of interest
expense allocated to income of a foreign corporation that is, or is
treated as, effectively connected with the conduct of a trade or
business in the United States (``excess interest'') is treated as
interest paid by a wholly-owned domestic corporation to the foreign
corporation. The foreign corporation is subject to tax under section
881 on the excess interest and is required to report the excess
interest on its income tax return, subject to the exemption provided in
section 881 for bank deposit interest and reduction or elimination
under applicable tax treaties. However, no withholding is required
under section 1441 and 1442. See Sec. 1.884-4(a)(2)(iv). Because no
withholding is required, excess interest is not excluded from treatment
as a base erosion tax benefit under the proposed regulations.
A comment suggested that because excess interest is subject to tax
under section 881(a) as if it were interest paid to a foreign
corporation by a wholly-owned domestic corporation, the exclusion from
base erosion tax benefits that applies to payments subject to full
withholding should also apply to excess interest. The comment suggested
that the exclusion from treatment as a base erosion tax benefit might
apply to excess interest under the proposed regulations, but requested
clarification. While excess interest would not be excluded from
treatment as a base erosion tax benefit under the proposed regulations
because it is not subject to withholding, the Treasury Department and
the IRS have determined that it is appropriate to expand the general
exclusion from base erosion tax benefits to include excess interest.
Accordingly, the final regulations reduce any base
[[Page 66987]]
erosion tax benefit attributable to interest in excess of interest on
U.S.-connected liabilities by excess interest to the extent that tax is
imposed on the foreign corporation with respect to the excess interest
under section 884(f) and Sec. 1.884-4, and the tax is properly
reported on the foreign corporation's income tax return and paid in
accordance with Sec. 1.884-4(a)(2)(iv). Sec. 1.59A-3(c)(2)(ii). If an
income tax treaty reduces the amount of tax imposed on the excess
interest, the amount of base erosion tax benefit under this rule is
reduced in proportion to the reduction in tax.
The final regulations also provide a coordination rule to clarify
the interaction between the withholding tax exception and the rules
determining the portion of interest expense attributable to ECI that is
treated as paid to a foreign related party. As discussed in part
IV.B.4. of this Summary of Comments Explanation of Revisions, interest
expense attributable to ECI that is in excess of direct allocations and
interest expense on U.S.-booked liabilities is treated as paid to a
foreign related party in proportion to the foreign corporation's
average worldwide ratio of interest expense paid to a foreign related
party over total interest expense. This coordination rule provides that
any interest, including branch interest under Sec. 1.884-4(b)(1), on
which tax is imposed under 871 or 881 and tax has been deducted and
withheld under section 1441 or 1442 but which is not attributable to
direct allocations or interest expense on U.S.-booked liabilities is
treated as not paid to a foreign related party for purposes of
determining the foreign corporation's average worldwide ratio.
2. Rule for Classifying Interest for Which a Deduction Is Allowed When
Section 163(j) or Another Provision of the Code Limits Deductions
Section 59A(c)(3) provides a stacking rule in cases in which
section 163(j) applies to a taxpayer, under which the reduction in the
amount of deductible interest is treated as allocable first to interest
paid or accrued to persons who are not related parties with respect to
the taxpayer and then to related parties. The statute does not provide
a rule for determining which portion of the interest treated as paid to
related parties (and thus potentially treated as a base erosion
payment) is treated as paid to a foreign related party as opposed to a
domestic related party. Proposed Sec. 1.59A-3(c)(4) provides rules
coordinating section 163(j) with the determination of the amount of
base erosion tax benefits. This rule provides, consistent with section
59A(c)(3), that where section 163(j) applies to limit the amount of a
taxpayer's business interest expense that is deductible in the taxable
year, a taxpayer is required to treat all disallowed business interest
first as interest paid or accrued to persons who are not related
parties, and then as interest paid or accrued to related parties for
purposes of section 59A. More specifically, with respect to interest
paid to related parties, the proposed regulations provide that the
amount of allowed business interest expense is treated first as the
business interest expense paid to related parties, proportionately
between foreign and domestic related parties. Conversely, the amount of
a disallowed business interest expense carryforward is treated first as
business interest expense paid to unrelated parties, and then as
business interest expense paid to related parties, proportionately
between foreign and domestic related-party business interest expense.
Proposed Sec. 1.59A-3(c)(4)(i)(C) provides that business interest
expense paid or accrued to a foreign related party to which the ECI
exception in proposed Sec. 1.59A-3(b)(3)(iii) applies is classified as
domestic related business interest expense. One comment observed that
the proposed regulations do not expressly provide similar rules for
business interest expense paid to foreign related parties that is
excluded from the definition of a base erosion payment under the TLAC
exception or excluded from the definition of a base erosion tax benefit
under the exception for payments subject to withholding tax. The final
regulations confirm that those categories of interest expense retain
their classification as payments to foreign related parties, but also
that the foreign related business interest expense category is treated
as consisting of interest that is eligible for these exceptions and
interest that is not eligible for these exceptions, on a pro-rata
basis. See Sec. 1.59A-3(c)(4)(i)(C)(2).
E. Election To Waive Allowable Deductions
See the 2019 proposed regulations for a proposal to provide an
election (and certain procedural safeguards) by which a taxpayer may
permanently forego a deduction for all U.S. federal tax purposes, with
the result that the foregone deduction will not be treated as a base
erosion tax benefit.
V. Comments and Changes To Proposed Sec. 1.59A-4--Modified Taxable
Income
Proposed Sec. 1.59A-4 contains rules relating to the determination
of modified taxable income.
A. Method of Computing Modified Taxable Income
Section 59A(c)(1) defines modified taxable income as ``the taxable
income of the taxpayer computed under this chapter for the taxable
year, determined without regard to--(A) any base erosion tax benefit
with respect to any base erosion payment, or (B) the base erosion
percentage of any net operating loss deduction allowed under section
172 for the taxable year.'' Proposed Sec. 1.59A-4(b)(2) clarifies that
modified taxable income is computed by adding back the base erosion tax
benefits and base erosion percentage of any net operating loss
deductions (the ``add-back method''). In addition, to prevent net
operating loss benefits from being duplicated, proposed Sec. 1.59A-
4(b)(1) provides that taxable income may not be reduced below zero as a
result of a net operating loss deduction.
Comments generally recommended one of three approaches to calculate
modified taxable income: (1) The add-back method, (2) the
``recomputation method,'' and (3) the ``limited recomputation method.''
1. The Add-Back Method
Some comments recommended that the final regulations retain the
add-back method because it would be simpler and easier to administer
this method than a recomputation method. See Part V.A.2 of this Summary
of Comments and Explanation of Revisions for a description of the
recomputation method. Comments highlighted that the add-back method
does not require attributes to be separately computed and tracked for
regular income tax purposes and the BEAT. In addition, a comment
asserted that this method more closely follows the statute, observing
that the statutory language in section 59A(c) is substantially
different from the recomputation-like language that was in section
59(a)(1)(B) relating to the foreign tax credit determination for
alternative minimum tax purposes, which is now repealed for
corporations. See section 59(a)(1)(B) (providing explicit language
referencing computing the alternative minimum tax foreign tax credit as
if section 904 were applied on the basis of alternative minimum taxable
income instead of taxable income); see also the Act, Sec. 12001(a)
(repealing the alternative minimum tax for corporations and rendering
section 59(a)(1)(B) inapplicable to corporations). Another comment
noted that the add-back method is harmonious with the language of
section 59A(c)(1)(B) because that section includes the base erosion
percentage of net operating loss
[[Page 66988]]
deductions as an item included in modified taxable income as the method
for determining which portion of net operating loss carryovers from
prior years resulted from base erosion tax benefits. (Under a
recomputation method with a net operating loss carryover that is
computed on a BEAT basis, base erosion tax benefits would already be
excluded from the net operating loss carryover, so it would be
anomalous to also apply section 59A(c)(1)(B) to the net operating loss
deduction.) In support of the add-back method, one comment asserted
that applying a recomputation approach would exceed statutory
authority.
2. The Recomputation Method
Some comments recommended that the final regulations determine
modified taxable income by using the recomputation method that is
described in the preamble to the proposed regulations whereby the
taxpayer's taxable income is recomputed without the excluded items, or
a variation of that method. See REG-104259-18, 83 FR 65965 (December
21, 2018) (describing a recomputation approach as requiring attributes
that are limited based on taxable income to be recomputed for purposes
of section 59A). For example, some comments recommended making the
recomputation method elective. One comment requested a recomputation
method with a special rule for net operating loss deductions, which is
discussed in Part V.A.3 of this Summary of Comments and Explanation of
Revisions (limited recomputation method). While comments acknowledged
that the add-back method is less complex, comments asserted that the
add-back method may result in greater BEAT liability. Comments claimed
that the recomputation method more accurately computes the base erosion
minimum tax amount (``BEMTA''). Comments also asserted that the
language in section 59A(c)--specifically the clause ``computed without
regard to''--is more consistent with the recomputation method. Another
comment noted that nothing in section 59A or its legislative history
mandates the use of the add-back method and that taxpayers familiar
with the prior corporate alternative minimum tax would have anticipated
using the recomputation method.
Additionally, some comments requested a recomputation method with a
separate tracking of attributes such as net operating loss carryovers,
while others requested a recomputation method without a separate
tracking of attributes. Some comments acknowledged that the
recomputation method could give taxpayers a double benefit from non-
base eroding deductions unless it required separate tracking of
attributes for purposes of the BEAT. For example, one comment noted
that the recomputation method would generally allow net operating loss
carryovers to be used more rapidly for purposes of modified taxable
income than for regular tax purposes because the taxable income
limitation under section 172 on net operating loss deductions would be
lower for regular tax purposes. As a result, the comment noted that if
net operating loss carryovers are not separately tracked for purposes
of the BEAT, a taxpayer may receive a double benefit from the non-base
eroding deductions because those attributes reduce modified taxable
income in the loss year, but if the attributes do not reduce the
taxpayer's regular tax liability, the attributes would remain available
to reduce modified taxable income in a future year. In contrast,
another comment asserted that attributes should not be separately
tracked because section 59A requires a snapshot of relative tax
attributes that are applied independently to calculate taxable income
and modified taxable income.
3. The Limited Recomputation Method
Some comments recommended that the final regulations permit a
taxpayer to elect to recompute its taxable income with respect to pre-
2018 net operating loss carryovers (the ``limited recomputation
method''). Under this approach, comments generally suggested the
taxpayer would use the add-back method except with respect to pre-2018
net operating loss carryovers, which would be separately used and
tracked for purposes of the BEAT. One comment suggested that this
approach should apply to net operating losses generally, not only pre-
2018 net operating loss carryovers. Comments asserted that the proposed
regulations have the effect of denying some taxpayers the economic
benefit of their pre-2018 net operating loss carryovers because they do
not allow pre-2018 net operating loss carryovers to offset full tax
liability of taxpayers. Some comments acknowledged that using net
operating loss carryovers under any of the three methods discussed in
this Part V.A of the Summary of Comments and Explanation of Revisions
are timing differences (rather than permanent differences that would
deny economic benefit) because pre-2018 net operating loss carryovers
are allowed against modified taxable income as and when those net
operating loss carryovers are deducted for regular tax purposes.
Comments generally asserted that limiting the utilization of net
operating loss carryovers is arguably retroactive in nature because it
limits the tax benefit of pre-2018 net operating loss carryovers and is
unduly harsh because it may cause a taxpayer to pay tax on an amount
greater than its economic income. Some comments also asserted that the
limited recomputation approach is more consistent with pre-Act section
172 and the policies supporting section 59A. The comments noted that
the section 172 legislative history suggests that net operating loss
deductions were allowed primarily to alleviate economic losses incurred
by taxpayers and asserted that absent clear statutory language and
expressed legislative intent to limit the use of net operating losses,
taxpayers should be able to use the net operating loss carryovers
without limitation in calculating their modified taxable income.
However, the comment acknowledged that an attribute tracking system is
required to prevent the same net operating loss carryovers from being
deducted multiple times for the BEAT.
4. Add-Back Method Retained in Final Regulations
The final regulations retain the add-back method. The add-back
method takes into account all the statutory language in section
59A(c)(1), which determines modified taxable income without regard to
both the base erosion tax benefits and the base erosion percentage of
net operating loss deductions. This approach is also consistent with
the Joint Committee on Taxation's Explanation of the Act, which states
that ``an applicable taxpayer's modified taxable income is its taxable
income for the taxable year, increased by (1) any base erosion tax
benefit with respect to any base erosion payment and (2) the base
erosion percentage of any NOL deduction allowed under section 172 for
such taxable year.'' Joint Comm. on Tax'n, General Explanation of
Public Law 115-97 (``Bluebook''), at 403 (emphasis added). By contrast,
the recomputation method conflicts with section 59A(c)(1). If taxable
income is recomputed without any base erosion tax benefits for modified
taxable income, it is a necessary premise that net operating loss
carryovers would also be recomputed as BEAT-basis attributes, which,
under the recomputation framework, would not include the effect of any
base erosion tax benefits (because the recomputation method is without
regard to base erosion tax benefits). However, that framework would
make the language in section 59A(c)(1)(B)
[[Page 66989]]
superfluous or inexplicable because section 59A(c)(1)(B) addresses the
percentage of base erosion tax benefits embedded in a net operating
loss carryover, whereas a recomputed BEAT-basis net operating loss
carryover would already exclude all base erosion tax benefits.\3\
---------------------------------------------------------------------------
\3\ For example, assume that a domestic corporation (DC) is an
applicable taxpayer that has a calendar year. In 2020, DC has gross
income of $0, a deduction of $60x that is not a base erosion tax
benefit, and a deduction of $40x that is a base erosion tax benefit.
For regular tax purposes, DC has a net operating loss carryover
within the meaning of section 172(b) of $100x. DC also has a base
erosion percentage of 40 percent for the 2020 taxable year. Under
the recomputation method, DC's taxable income would presumably be
recomputed without regard to base erosion tax benefits, and as a
result, DC would presumably have a BEAT-basis net operating loss
carryover of $60x, computed as DC's excess of deductions over gross
income, without regard to the $40x of deductions that are base
erosion tax benefits.
Assume further that in 2021, DC has gross income of $70x, and no
current year deductions. For regular tax purposes, DC is permitted a
net operating loss deduction of $56x (section 172(a) limits the
regular tax deduction for net operating losses that originated after
the Act to 80 percent of taxable income before the net operating
loss deduction), and thus DC has regular taxable income of $14x
($70x - $56x = $14x). Under the add-back method, DC's modified
taxable income for 2021 would be computed as $36.4x, computed as
regular taxable income of $14x, plus $0 base erosion tax benefits in
2021, plus the section 59A(c)(1)(B) base erosion percentage of the
net operating loss allowed under section 172, $22.4x ($56x x 40
percent = $22.4x).
Under the recomputation method, DC would presumably need to
recompute its 2021 taxable income without regard to its base erosion
tax benefits in 2021 (there are none in the example) and also
without regard to the base erosion percentage of the net operating
loss deduction allowed under section 172 for the taxable year
($56x). Section 59A(c)(1)(B). However, the basic premise of the
recomputation method is that DC has a BEAT-basis net operating loss
carryover from 2020 of $60x that already excludes the 2020 base
erosion tax benefits. DC's modified taxable income for 2021 might
thus be computed as $14x ($70x gross income, reduced by $56x, which
is the lesser of (i) the $60x BEAT-basis net operating loss
carryover from 2020 or (ii) 80 percent of the taxable income ($70x)
computed without regard to the section 172 deduction, or $56x).
However that adaptation would render section 59A(c)(1)(B)
irrelevant. If instead, section 59A(c)(1)(B) was taken into account
in computing DC's modified taxable income, then DC's modified
taxable income would include the erosion percentage (40 percent) of
the BEAT-basis net operating loss carryover from 2020 ($60x), even
though that BEAT-basis net operating loss carryover has already been
stripped of any 2020 base erosion tax benefits. Thus, this
adaptation that gives regard to section 59A(c)(1)(B) would seem to
incongruously increase modified taxable income by $24x (40 percent
of $60x = $24x). Some comments observed these anomalies, but no
comments appear to provide a complete reconciliation of how the
recomputation method would address the anomalies under the terms of
the statute.
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Further, as some comments noted, the add-back method is more
consistent with the statutory framework of section 59A because the add-
back method does not require additional rules regarding the treatment
of separate tax attributes. The Treasury Department and the IRS have
determined, and numerous comments acknowledged, that if the
recomputation method were used, separate tracking of attributes would
be required to avoid duplication of benefits. Unlike the alternative
minimum tax that was repealed for corporations, the BEAT does not
contain rules to address how a recomputation method would be
implemented, including in the case of a section 381 transaction, a
section 382 ownership change, or a deconsolidation. Thus, the
recomputation methods would require the Treasury Department and the IRS
to construct such rules by regulation. Moreover, as also identified by
comments, the add-back method is simpler and easier to comply with and
administer for both taxpayers and the IRS than the recomputation method
or other methods (including a method by which a taxpayer could elect to
apply the add-back or recomputation method) because the recomputation-
based methods would require the taxpayer to calculate an entire
parallel tax return and schedules to take into account iterative
effects, whereas the add-back approach only requires addition, rather
than iterative effects. As a result of these factors, the Treasury
Department and the IRS have determined that it is not appropriate to
permit the recomputation method.
These reasons for rejecting the recomputation method also apply to
the limited recomputation method. Because the recomputation approach
generally is not consistent with the statutory construct, it would be
inappropriate to create a limited version of that approach to permit a
taxpayer to use its pre-2018 net operating loss carryovers or all net
operating loss carryovers. Section 59A does not provide special rules
or preferences for pre-2018 net operating loss carryovers. In addition,
the comments' assertions for pre-2018 net operating loss carryovers
generally apply to subsequent net operating loss carryovers of certain
taxpayers, and those carryovers would raise all the issues discussed.
The claim that taxpayers are losing the benefit of their net
operating loss carryovers as a result of the add-back method in the
proposed regulations is erroneous. Net operating loss carryovers
continue to offset regular taxable income. Section 59A does not change
that result, as the net operating loss deduction is allowed against
modified taxable income as and when deducted for regular tax purposes.
Section 172 does not provide that if a taxpayer has a net operating
loss carryover then the taxpayer does not have to pay any taxes under
any provision. Because the base erosion percentage of any net operating
loss deduction is taken into account in determining modified taxable
income, section 59A(c)(1)(B) specifically contemplates that a taxpayer
may not obtain the full benefit of net operating loss carryovers even
in a year in which the taxpayer uses a net operating loss deduction to
fully offset taxable income for purposes of its regular tax liability.
Moreover, the statutory language in section 59A does not explicitly
limit that provision to net operating loss deductions related to
carryovers that originated in tax years beginning after December 31,
2017; rather, that limitation resulted from the vintage year approach
adopted in proposed Sec. 1.59A-4(b)(2)(ii). Absent that provision, or
if proposed Sec. 1.59A-4(b)(2)(ii) had adopted a current year base
erosion percentage approach, the add-back provision in section
59A(c)(1)(B) could have also applied to net operating loss deductions
related to carryovers that originated in pre-2018 tax years. See Part
V.B of this Summary of Comments and Explanation of Revisions for a
discussion of the comments related to proposed Sec. 1.59A-4(b)(1) and
limiting the net operating loss deduction for purposes of computing
modified taxable income.
B. Amount of Net Operating Loss Deduction From Net Operating Loss
Carryovers
Under the add-back method, section 59A(c) provides that the
computation of modified taxable income starts with the taxpayer's
regular taxable income for the year. Section 172(a) generally provides
that for regular tax purposes a deduction is allowed for the tax year
in an amount equal to the net operating loss carryover to the year. For
net operating loss carryovers originating after the Act, the net
operating loss deduction is generally limited for regular tax purposes
to 80 percent of taxable income computed without regard to the net
operating loss deduction. Section 172(a). For net operating loss
carryovers originating before the Act, the net operating loss carryover
deduction generally is not limited for regular tax purposes. Section
13302(e)(1) of the Act. Proposed Sec. 1.59A-4(b)(1) provides that
taxable income may not be reduced below zero as a result of net
operating loss deductions. The preamble to the proposed regulations
explains that the rule is necessary because section 172(a) could be
read to provide that the same net operating loss carryover could reduce
modified taxable income in multiple years. REG-104259-18, 83 FR 65965
(December 21, 2018).
[[Page 66990]]
The preamble to the proposed regulations provides an example where
a taxpayer has a net operating loss carryover of $100x that arose in a
taxable year beginning before January 1, 2018. REG-104259-18, 83 FR
65965 (December 21, 2018). In a subsequent year, the taxpayer has
taxable income of $5x before taking into account the $100x net
operating loss carryover. Absent the rule in proposed Sec. 1.59A-
4(b)(1), the taxpayer might claim the entire $100x net operating loss
carryover as a $100x deduction in that year to create a $95x taxable
loss for determining modified taxable income, even though $95x of the
net operating loss carryover would remain as a carryover to future
years. Proposed Sec. 1.59A-4(b)(1) ensures that a net operating loss
is taken into account only once in determining a taxpayer's modified
taxable income.
Some comments recognized the need for proposed Sec. 1.59A-4(b)(1)
consistent with the preamble to the proposed regulations. A comment
acknowledged that if the net operating loss carryover deductions are
not limited to the amount of taxable income, those net operating losses
could reduce taxable income--and therefore the taxpayer's BEAT
liability--multiple times. Another comment noted that, without proposed
Sec. 1.59A-4(b)(1), allowing net operating loss carryovers to be taken
into account for modified taxable income to the same extent as general
taxable income would give rise to certain complex questions concerning
net operating loss carryovers for general tax purposes.
Other comments asserted that there is no authority in section 59A
for limiting the net operating loss deduction to the amount of taxable
income, that the rule in proposed Sec. 1.59A-4(b)(1) is contrary to
the statute, and that the final regulations should permit taxable
income to be negative as a result of net operating loss carryovers.
Comments noted that modified taxable income is determined based on
taxable income, which generally is gross income minus deductions
allowed under chapter 1, including the net operating loss deduction.
Another comment noted that with respect to the amount of net operating
loss deduction in a taxable year, when Congress wants to place a floor
on a number, it does so expressly; for example, section 59A(b)(1)(B)
provides that regular tax liability is ``reduced (but not below
zero).'' In contrast, there is no similar language in section 59A or
section 172(a) prior to the Act for net operating loss deductions.
Comments also asserted that the limitation on the use of net
operating loss carryovers as deductions in a taxable year causes
taxpayers to be liable for tax pursuant to the BEAT on their base
erosion tax benefits even though they are not liable for regular income
tax because of their net operating loss deductions that reduced regular
taxable income to zero. Comments also asserted that the proposed
regulations effectively reduce the extent to which the net operating
loss carryforwards may be used.
Other comments requested that the final regulations provide a
transition to the proposed rule preventing taxable income to be
negative as a result of a net operating loss deduction. One comment
requested that final regulations provide for a deferral of the
effective date of proposed Sec. 1.59A-4(b)(1) of one or two years.
Another comment requested that final regulations provide that taxpayers
may reduce their BEAT liability by (a) an amount equal to the pre-2018
net operating loss carryover that offset taxable income, multiplied by
(b) the difference between the regular income tax rate and the BEAT
rate because section 59A should not retroactively reduce the value of
the pre-2018 net operating loss carryovers. These comments also
highlighted a situation where a taxpayer's regular taxable income is
reduced entirely by available pre-2018 net operating loss carryovers,
but the taxpayer also has base erosion tax benefits that increase
modified taxable income, causing a BEAT liability. The comments
asserted that imposing BEAT on this modified taxable income amounts to
a retroactive reduction in the value of the taxpayer's pre-2018 net
operating loss carryovers, and recommended that the final regulations
adopt this methodology by which pre-2018 attributes are provided a 21
percent tax rate benefit, which is similar to the limited recomputation
method discussed in Part V.A of this Summary of Comments and
Explanation of Revisions.
These comments are not adopted in the final regulations. First, the
comments focused on a technical reading of section 172(a) as it applies
to net operating loss carryovers that originated before the Act. That
version of section 172(a) did not expressly limit the amount of net
operating loss deduction for regular tax purposes to 100 percent of
taxable income computed without regard to the net operating loss
deduction. As it existed before the Act, there was no reason to limit
the section 172(a) deduction in this manner because before the Act
there was no consequence to claiming a net operating loss deduction
greater than 100 percent of current year taxable income. For example,
before the Act, a taxpayer's net operating loss carryover was only
reduced by the amount of net operating loss deduction that was actually
used to reduce taxable income to zero. See Sec. 1.172-4(a)(3).
In addition to the technical reading of section 172(a) as it
applies to net operating loss carryovers that originated before the
Act, the Treasury Department and the IRS continue to believe,
consistent with some of the comments received, that limiting net
operating loss deductions to the amount of taxable income for purposes
of computing modified taxable income is necessary and appropriate to
prevent net operating loss carryovers from being used multiple times to
reduce modified taxable income. If the final regulations did not limit
the amount of net operating loss carryover deductions for purposes of
calculating modified taxable income, a taxpayer with a large pre-2018
net operating loss carryover would be able to reduce modified taxable
income in multiple years with the same net operating loss carryover,
without reducing the net operating loss carryover for regular income
tax purposes.
The fact that taxpayers with sufficiently large pre-2018 net
operating loss carryovers may be able to avoid paying regular income
tax in a taxable year does not mean that those taxpayers should be
permitted to offset the entire amount of their BEAT liability in that
taxable year, or in other words, not be liable for tax under the BEAT.
As discussed in Part V.A. of this Summary of Comments and Explanation
of Revisions, the limitation on net operating loss deductions for
determining modified taxable income impacts only the BEMTA. This
limitation does not prevent the use of pre-2018 net operating loss
carryover to reduce regular taxable income to zero. Further, to the
extent a taxpayer's pre-2018 net operating loss carryovers exceed the
taxpayer's taxable income, the taxpayer continues to use those
remaining net operating loss carryovers in later years to offset some
or all regular taxable income; and the taxpayer continues to reduce
modified taxable income by the same amount in those later years.
A comment asserted that the add-back method creates an economic
disparity between similarly situated taxpayers because taxpayers
without pre-2018 net operating loss carryovers can make more base
erosion payments than taxpayers with pre-2018 net operating loss
carryovers before being subject to BEAT liability. However, taxpayers
with pre-2018 net operating loss carryovers are not similarly situated
to taxpayers
[[Page 66991]]
without pre-2018 net operating loss carryovers, as the former are
paying less regular income taxes than the latter, which is a factor in
determining the amount of BEAT liability.
One comment questioned why current year losses can result in
negative taxable income for BEAT purposes, while net operating losses
that are carried to a different year cannot result in negative taxable
income in that different year. Proposed Sec. 1.59A-4(b)(1) permits
taxpayers that have current year losses to use that negative income
amount as a starting point for computing modified taxable income
because the Treasury Department and the IRS determined that if
taxpayers were not permitted to use that negative amount as a starting
point for calculating modified taxable income, the base erosion tax
benefits for that year could be double counted. That is, the base
erosion tax benefits for that year could be included in modified
taxable income for the current year and in the year the net operating
loss carryover is used because of the add-back of the base erosion
percentage of the net operating loss deduction in the year used.
Because of this concern, the proposed regulations expressly permit
current year losses to be taken into account as the starting point for
computing modified taxable income. Proposed Sec. Sec. 1.59A-4(b)(1)
and (c).
Section 59A(i) provides a broad grant of regulatory authority,
permitting the Secretary to prescribe regulations as may be necessary
or appropriate to carry out the provisions of the section. For the
reasons discussed, the Treasury Department and the IRS have determined
that limiting the net operating loss deduction to taxable income in
computing modified taxable income is within the grant of authority, and
the final regulations do not adopt the comments requesting a different
rule. The final regulations also do not adopt a rule providing a fixed
21 percent tax rate benefit for all pre-2018 net operating loss
carryovers. The fact that a taxpayer may have positive modified taxable
income (resulting in a positive BEAT tax liability) even if the
taxpayer has a lesser amount of regular taxable income because pre-2018
net operating loss carryovers reduce taxable income is a part of the
statutory framework of the BEAT; that is, imposing tax on a modified
taxable income base. See also, the response to the limited
recomputation method discussed in Part V.A of this Summary of Comments
and Explanation of Revisions.
C. Use of Aggregate Base Erosion Percentage for Net Operating Loss
Deductions
Proposed Sec. 1.59A-4(b)(1) generally defines modified taxable
income as a taxpayer's taxable income computed under chapter 1,
determined without regard to base erosion tax benefits and the base
erosion percentage of any net operating loss deduction under section
172 for the taxable year. Under the proposed regulations, the base
erosion percentage for the year that the net operating loss carryover
arose (the ``vintage year'' base erosion percentage) is used to compute
modified taxable income. Proposed Sec. 1.59A-4(b)(2)(ii). Although the
computation of modified taxable income is made on a taxpayer-by-
taxpayer basis, the proposed regulations clarify that in computing the
add-back for net operating loss deductions, the relevant base erosion
percentage is the base erosion percentage for the aggregate group,
which is used to determine whether the taxpayer is an applicable
taxpayer.
A comment noted that an aggregate base erosion percentage could
potentially take into account deductions of another aggregate group
member that are not otherwise included in a taxpayer's return. The
comment questioned whether a more precise determination of a taxpayer's
vintage year base erosion percentage is appropriate.
The Treasury Department and the IRS have determined that the base
erosion percentage that is applied to net operating loss deductions
when computing modified taxable income should be computed on the basis
of the taxpayer and its aggregate group in the same manner as the base
erosion percentage that is computed for determining whether the
taxpayer is an applicable taxpayer under section 59A(e). Section
59A(e)(3) requires aggregation for purposes of computing the base
erosion percentage that is used to determine whether a taxpayer is an
applicable taxpayer and to determine the portion of net operating loss
deductions that are included in computing modified taxable income
pursuant to section 59A(c)(1)(B). Because Congress chose to determine
the base erosion percentage on an aggregate basis, it follows that one
aggregate group member's deductions can affect the base erosion
percentage that will apply with respect to another member of the group.
For these reasons, the final regulations do not revise the rules for
determining the base erosion percentage that is applied to net
operating loss deductions when computing modified taxable income.
D. Operation of Vintage Approach for Net Operating Losses
Section 59A(c)(1)(B) provides that modified taxable income includes
the base erosion percentage of any net operating loss deduction allowed
under section 172 for the taxable year. Proposed Sec. 1.59A-
4(b)(2)(ii) provides that the base erosion percentage of the year in
which the loss arose, or the ``vintage year,'' is used to compute
modified taxable income rather than the base erosion percentage in the
year in which the taxpayer takes the net operating loss deduction.
One comment requested guidance on how the vintage year approach is
applied when in the vintage year the taxpayer has both deductions that
are base erosion tax benefits and deductions that are not base erosion
tax benefits. The comment stated that it is not clear how to compute or
order the base erosion percentage because the proposed regulations do
not provide rules for determining which type of deductions were used in
that vintage year to offset gross income, and which deductions were
carried forward as net operating loss carryforwards. The comment
provided an example in which the taxpayer in year 1 has gross income of
$800x and deductions of $1000x that consist of $250x of base erosion
tax benefits and $750x of non-base erosion tax benefits, resulting in a
$200x net operating loss. The comment requested clarification for
determining how the deductions are ordered for determining the base
erosion percentage of the year 1 $200x net operating loss carryover
when that carryover is deducted in a later year.
The final regulations do not revise the vintage year rule because
section 59A(c)(1)(B) and the proposed regulations already provide that
the base erosion percentage used with respect to the net operating loss
deduction is the base erosion percentage of the taxpayer in the
relevant taxable year (in this example, $250x/$1000x = 25 percent).
That is, no specific ordering rule is required because the base erosion
percentage calculation for the vintage year takes into account a
proportionate amount of each type of deduction (or $250x divided by
$1000x in the example).
Another comment suggested that in applying the vintage year
approach to net operating loss deductions, a simplifying convention
should be provided to address target corporations that have net
operating loss carryovers and become members of a taxpayer's
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aggregate group by acquisition. The comment suggested that taxpayers be
permitted to elect to use their current year base erosion percentage
with respect to the net operating loss deductions, rather than the
vintage year base erosion percentage of the target because it may be
complicated to determine the target's vintage year base erosion
percentage. The comment specifically noted the difficulty in cases
where the target was not an applicable taxpayer in the vintage year.
The final regulations do not adopt this elective approach. Because the
net operating loss carryover is an attribute of the target corporation,
the target corporation is required to maintain documentation to support
both the carryover amount and the other aspects of its attributes that
affect the target corporation's tax liability--namely the base erosion
percentage with respect to its net operating loss carryovers.
Accordingly, the acquiring corporation should be able to obtain the
information necessary to determine the target corporation's vintage
year base erosion percentage.
VI. Comments and Changes to Proposed Sec. 1.59A-5--BEMTA
Proposed Sec. 1.59A-5 contains rules regarding the calculation of
BEMTA and provides the base erosion and anti-abuse tax rate that
applies to the taxpayer's taxable year. The proposed regulations
provide that an applicable taxpayer computes its BEMTA for the taxable
year to determine its liability under section 59A(a). Proposed Sec.
1.59A-5(b). Generally, the taxpayer's BEMTA equals the excess of (1)
the applicable tax rate for the taxable year (``BEAT rate'') multiplied
by the taxpayer's modified taxable income for the taxable year over (2)
the taxpayer's adjusted regular tax liability for that year. Proposed
Sec. 1.59A-5(b). In determining the taxpayer's adjusted regular tax
liability for the taxable year, credits (including the foreign tax
credit) are generally subtracted from the regular tax liability amount.
Proposed Sec. 1.59A-5(b)(2). Consistent with section 59A(b)(1)(B), the
proposed regulations provide that for taxable years beginning before
January 1, 2026, the credits allowed against regular tax liability
(which reduce the amount of regular tax liability for purposes of
calculating BEMTA) are not reduced by the research credit determined
under section 41(a) or by a portion of applicable section 38 credits.
To prevent an inappropriate understatement of a taxpayer's adjusted
regular tax liability, the proposed regulations provide that credits
for overpayment of taxes and for taxes withheld at source are not
subtracted from the taxpayer's regular tax liability because these
credits relate to U.S. federal income tax paid for the current or
previous year. Proposed Sec. 1.59A-5(b)(3)(i)(C) and (ii).
A. Applicability of Aggregation Rule to BEMTA
The proposed regulations provide that the computations of modified
taxable income and BEMTA are done on a taxpayer-by-taxpayer basis. That
is, the aggregate group concept is used solely for determining whether
a taxpayer is an applicable taxpayer, and does not apply to the
computations of modified taxable income and the BEMTA. The preamble to
the proposed regulations explains that if taxpayers calculated BEMTA
differently depending on their differing views of the base on which the
BEAT should be calculated (that is, aggregate group, consolidated
group, individual company), this could lead to inequitable results
across otherwise similar taxpayers. REG-104259-18, 83 FR 65974
(December 21, 2018).
The proposed regulations also explain that it is expected to be
less costly for taxpayers to calculate BEMTA on a taxpayer-by-taxpayer
basis because the statutory framework of section 59A applies in
addition to the regular tax liability of a taxpayer. Calculating BEAT
liability at an aggregate level, for example, would require any BEAT
liability to be reallocated among the separate taxpayers.
Comments requested that electing taxpayers be permitted to apply
the aggregation rules of section 59A(e)(3) to determine their modified
taxable income and BEMTA. Electing taxpayers would effectively compute
modified taxable income and BEMTA at the level of the aggregate group
rather than at the level of the separate taxpayer.
The comments explained that aggregation would permit a group with
multiple consolidated returns to be given full credit for the group's
contributions to the U.S. tax base. Comments further explained that, in
certain instances, business, legal, or regulatory reasons prevent
groups with multiple taxpayers from forming an affiliated group of
corporations within the meaning of section 1504 that can file a single
consolidated return. However, the comments asserted that these groups
still represent a single economic unit where they have a common parent
and overall management, share services, and are generally treated as a
single employer.
Comments also suggested that an election to apply the aggregation
rules for BEMTA would prevent inequitable results in the application of
the BEAT. For example, some comments suggested that it would be
inequitable for a single consolidated group within an aggregate group
that had a large amount of NOLs, minimal regular tax liability, and
little to no base erosion payments to be subject to the BEAT as a
result of a separate consolidated group's high base erosion percentage.
The comments suggested that an aggregate approach would result in
an insignificant amount of additional complexity and little additional
burden to taxpayers and the government. Comments also made suggestions
regarding particular requirements of the election, such as requirements
that each taxpayer joining the election have the same taxable year-end,
agree to provide the IRS with all information needed to compute the
aggregate BEAT liability, agree to be allocated a pro-rata share of the
aggregate BEAT liability, and give consent for the statute of
limitations to remain open until the audits of all group members with
respect to the information used to determine that aggregate BEAT
liability have closed.
The final regulations do not adopt the recommendations. The
Treasury Department and the IRS recognize that, in determining whether
a taxpayer is an applicable taxpayer, and for determining certain
computational matters relating to modified taxable income and the
BEMTA, section 59A applies by reference to the taxpayer and the members
of its aggregate group. Section 59A does not explicitly extend that
aggregate group treatment to the computation of a taxpayer's BEMTA or
the resulting tax liability. The rules relating to the aggregate group
concept are complex, and they produce meaningful differences from the
single-entity concepts in the consolidated return regulations. See Part
III of this Summary of Comments and Explanation of Revisions. Section
1502 and the regulations thereunder contain detailed rules for
implementing the single taxpayer elements of the consolidated return
regulations. No similar rules are expressly contemplated in section 59A
with respect to BEMTA. Adding similar rules to these final regulations
would add significant complexity and would require the IRS to audit a
parallel BEMTA computation system. Consistent with section 1502 and the
regulations thereunder, aggregate groups of taxpayers that file a
consolidated return must compute BEMTA on a single-entity basis under
section 59A and the final regulations. See Sec. 1.1502-59A(b).
Therefore, the final regulations continue to provide that BEMTA is
calculated on a taxpayer-by-taxpayer basis.
[[Page 66993]]
B. Treatment of General Business Credits and Foreign Tax Credits
A comment noted that taxpayers may have credits generated in
taxable years beginning before January 1, 2018, that carry forward to
be used in taxable years beginning after December 31, 2017. In the case
of net operating losses that arose in taxable years beginning before
January 1, 2018, and that are deducted as carryovers in taxable years
beginning after December 31, 2017, the comment also noted that proposed
Sec. 1.59A-4(b)(2)(ii) provides that those deductions are excluded
from modified taxable income.
The comment requested that the final regulations exclude section 38
credits and foreign tax credits generated in pre-2018 taxable years
from the definition of credits allowed under chapter 1 of the Code. As
a result of this request, these credits would not be subtracted from
the regular tax liability amount in determining BEMTA. Alternatively,
the comment requested that the partial exclusion of section 38 credits
from the calculation of BEMTA in proposed Sec. 1.59A-5(b)(3)(i)(B) be
extended to foreign tax credits.
The final regulations do not adopt this comment. With respect to
net operating losses that arose in taxable years beginning before
January 1, 2018, the exclusion of these deductions from the calculation
of modified taxable income results from two statutory elements: (i)
Section 59A(c)(1) provides that the starting point for modified taxable
income is ``taxable income of the taxpayer computed under [chapter 1 of
the Code] for the taxable year . . .''; that is, modified taxable
income starts with taxable income, as reduced for any net operating
loss deduction under section 172; and (ii) section 59A(c)(1)(B)
provides that modified taxable income includes, or adds back to taxable
income, the base erosion percentage of any NOL deduction under section
172 for the taxable year. This statutory framework for determining
modified taxable income establishes that section 59A permits the net
operating loss deduction to reduce some or all of the current year's
pre-NOL taxable income, but that a portion of the tax benefit from that
NOL deduction is added back to taxable income. Further, Sec. 1.59A-
4(b)(2)(ii) applies the base erosion percentage of the year in which
the loss arose for this purpose, which effectively means that net
operating losses incurred in taxable years ending on or before December
31, 2017, are entirely excluded from the calculation from modified
taxable income when those deductions are used to reduce or eliminate
regular taxable income. In contrast to this explicit statutory
framework that addresses the lifecycle of the net operating loss
carryforward, section 59A does not provide a similar rule for credits.
Instead, section 59A(b)(1)(B) provides that all credits allowed under
chapter 1 of the Code against regular taxable income for the taxable
year are excluded from the calculation of BEMTA, except for
specifically enumerated credits that are partially or fully allowed to
reduce BEMTA. Because section 59A(b)(1) refers to all credits allowed
to reduce taxable income during the taxable year and makes no
distinction as between those credits that originated in the current
taxable year or a prior taxable year, the Treasury Department and the
IRS have determined that the proposed regulations are consistent with
the statute, and the final regulations retain the same rules with
respect to section 38 credits and foreign tax credits.
C. Exclusion of AMT Credits From Credits Reducing Regular Tax Liability
Generally, a taxpayer's BEMTA equals the excess of (1) the
applicable tax rate for the year multiplied by the taxpayer's modified
taxable income for the taxable year over (2) the taxpayer's adjusted
regular tax liability for that year. In determining the taxpayer's
adjusted regular tax liability for the taxable year, credits are
generally subtracted from the regular tax liability amount. To prevent
an inappropriate understatement of a taxpayer's adjusted regular tax
liability, the proposed regulations provide that credits for
overpayment of taxes and for taxes withheld at source are not
subtracted from the taxpayer's regular tax liability because these
credits relate to U.S. federal income tax paid for the current or
previous year.
Historically, an alternative minimum tax (``AMT'') was imposed on a
corporation to the extent the corporation's tentative minimum tax
exceeded its regular tax. If a corporation was subject to AMT in any
year, the amount of AMT was allowed as an AMT credit in any subsequent
taxable year to the extent the corporation's regular tax liability
exceeded its tentative minimum tax in the subsequent year. Bluebook,
pp. 92, 94.
The Act repealed the corporate AMT, and allows the corporate AMT
credit to offset the entire regular tax liability of the corporation
for a taxable year. In addition, the AMT credit is allowable and
generally refundable for a taxable year beginning after 2017 and before
2022 in an amount equal to 50 percent (100 percent in the case of
taxable years beginning in 2021) of the excess (if any) of the minimum
tax credit for the taxable year over the amount of the credit allowed
for the year against regular tax liability. Bluebook p. 97.
Comments requested that AMT credits be excluded from the
calculation of credits that reduce adjusted regular tax liability
because they represent income taxes imposed in a previous tax year and
allowed as credits in a subsequent tax year. The Treasury Department
and the IRS agree with these comments. Accordingly, Sec. 1.59A-5(b)(3)
provides that AMT credits, like overpayment of taxes and for taxes
withheld at source, do not reduce adjusted regular tax liability for
purposes of section 59A.
D. Rules Relating to Banks and Registered Securities Dealers for
Purposes of Computing the Base Erosion Percentage and Determining the
BEAT Rate for Computing BEMTA
Generally, under proposed Sec. 1.59A-2(e)(1), a taxpayer, or the
aggregate group of which the taxpayer is a member, satisfies the base
erosion percentage test to determine applicable taxpayer status if its
base erosion percentage is at least three percent. However, section
59A(e)(1)(C) and proposed Sec. 1.59A-2(e)(2)(i) provide that a lower
threshold of two percent applies if the taxpayer is a member of an
affiliated group (as defined in section 1504(a)(1)) that includes a
domestic bank or registered securities dealer. Proposed Sec. 1.59A-
2(e)(2)(ii) applies this two-percent threshold to the aggregate group
of which a taxpayer is a member that includes a bank or registered
securities dealer that is a member of an affiliated group. Proposed
Sec. 1.59A-2(e)(2)(iii) provides a de minimis exception to this lower
two-percent base erosion percentage threshold in the case of an
aggregate group or consolidated group that has de minimis bank or
registered securities dealer activities as measured by gross receipts.
Specifically, proposed Sec. 1.59A-2(e)(2)(iii) provides that an
aggregate group that includes a bank or a registered securities dealer
that is a member of an affiliated group is not treated as including a
bank or registered securities dealer for a taxable year if the total
gross receipts of the aggregate group attributable to the bank or the
registered securities dealer represent less than two percent of the
total gross receipts of the aggregate group (or consolidated group if
there is no aggregate group). Even if a taxpayer qualifies for the de
minimis exception to the lower base erosion percentage test threshold,
proposed Sec. 1.59A-5(c)(2) provides that the BEAT rate is increased
by an additional one percent for any
[[Page 66994]]
taxpayer that is a member of an affiliated group that includes a bank
or registered securities dealer. See section 59A(b)(3) (requiring that
the base erosion and anti-abuse tax rate in effect for the taxable year
for these taxpayers must be increased by one percentage point).
A comment requested that the final regulations provide for a higher
de minimis threshold of five percent and clarify that in characterizing
the income of a corporation with a bank or securities dealer division
for purposes of this threshold, only the gross receipts arising from
the conduct of the banking or securities business would be taken into
account. The Treasury Department and the IRS have determined that this
modification to the de minimis threshold is not warranted because this
de minimis exception in the proposed regulations was developed based on
a qualitative assessment of a very small degree of activities to
justify a regulatory-based exception to the statutory provision that
applies to a bank or registered securities dealer. Accordingly, the
final regulations retain the two-percent de minimis threshold.
Comments supported the proposed regulations' de minimis exception
to the lower base erosion percentage threshold and suggested that a
similar exception be created regarding the increased BEAT rate for a
taxpayer that is a member of an affiliated group with de minimis gross
receipts attributable to banking or securities dealer activities. In
instances where the base erosion percentage exceeds three percent, the
comments questioned the appropriateness of applying the BEAT rate add-
on of one percent to the non-financial members of the affiliated group
when the gross receipts of the financial members are insignificant
relative to the non-financial members.
The final regulations adopt this comment by revising Sec. 1.59A-
5(c)(2) to provide that the additional one percent add-on to the BEAT
rate will not apply to a taxpayer that is part of an affiliated group
with de minimis banking and securities dealer activities.
A comment recommended that an additional exception to the increased
BEAT rate should be provided where the bank or securities dealer
members of an affiliated group make no more than a de minimis amount of
base erosion payments, measured by reference to aggregate affiliated
group base erosion payments. The final regulations do not adopt this
recommendation because the base erosion percentage test already
operates as a statutory rule that limits the BEAT to taxpayers (without
regard to any particular type of business) that have a relatively low
degree of base erosion payments.
A comment requested that the final regulations include a transitory
ownership exception to apply where a bank or securities dealer is a
member of an affiliated group for only a short period (such as 90 days)
during the taxable year. The stated purpose of this request was to
allow time for a taxpayer that acquires a group that includes a bank or
registered securities dealer to dispose of the bank or securities
dealer member of a target affiliated group without causing the entire
acquiring affiliated group to become subject to the higher BEAT rate
applicable to taxpayers with bank or registered securities dealer
members. The Treasury Department and the IRS decline to expand the
regulatory de minimis exception to include an exception based on short-
term ownership, but note that a taxpayer in this situation may be
eligible for the de minimis regulatory exception if the bank and
securities dealer operations are relatively small. If the operations
are not sufficiently small, the statutory rules that apply to banks and
registered securities dealers would no longer apply in taxable years
after the disposition of the bank or securities dealer.
A comment observed that the rule in the proposed regulations
extending the lower base erosion percentage threshold to the entire
aggregate group that includes a bank or registered securities dealer is
not supported by the language of section 59A. The comment proposed that
the proper application of section 59A requires that the lower base
erosion percentage should be limited to only the affiliated group that
includes a bank or registered securities dealer, and not the remainder
of the taxpayer's aggregate group. The final regulations do not adopt
this comment. The Treasury Department and the IRS note that section
59A(e)(3) specifically requires aggregation for purposes of computing
the base erosion percentage. Further, the implication of the comment is
that in measuring whether a particular taxpayer has a base erosion
percentage that is greater than the prescribed level in section
59A(e)(3)(C), the threshold level would be blended. That is, under the
approach recommended by the comment, a taxpayer with a bank or
securities dealer in its aggregate group would compute a relative
weighting of the bank/dealers (two percent threshold) vs. non-bank/
dealers (three percent threshold) in order to compute a blended
threshold that is used for the base erosion percentage test. There is
no indication in the statutory language supporting this approach.
Accordingly, no changes are made to the final regulations in this
regard.
E. Applicability of Section 15 to the BEAT Rate
Section 59A(b)(1)(A) provides that the base erosion minimum tax
amount of an applicable taxpayer for any taxable year is the excess of
an amount equal to 10 percent (5 percent in the case of taxable years
beginning in calendar year 2018) of the modified taxable income of the
taxpayer for the taxable year. Proposed Sec. 1.59A-5(c) provides the
base erosion and anti-abuse tax rates that apply for purposes of
calculating the BEMTA. The base erosion and anti-abuse tax rate is five
percent for taxable years beginning in calendar year 2018 and 10
percent for taxable years beginning after December 31, 2018, and before
January 1, 2026. Proposed Sec. 1.59A-5(c)(1)(i) and (ii). Proposed
Sec. 1.59A-5(c)(3) provides that section 15 does not apply to any
taxable year that includes January 1, 2018, and further provides that
for a taxpayer using a taxable year other than the calendar year,
section 15 applies to any taxable year beginning after January 1, 2018.
In the case of taxpayers that use a taxable year other than the
calendar year and that includes January 1, 2019, this proposed
regulation provides that section 15 applies to the change in the
section 59A tax rate from 5 percent to 10 percent, based on an
effective date of January 1, 2019.
Several comments asserted that final regulations should provide
that section 15 applies only to the change in tax rate set forth in
section 59A(b)(2) and should not apply to the change in tax rate
included in section 59A(b)(1)(A) for taxable years beginning in
calendar year 2018. The final regulations adopt this comment. In
adopting this comment that section 15 not apply to the change in tax
rate included in section 59A(b)(1)(A) for taxable years beginning in
calendar year 2018, the final regulations provide no inference as to
the application of section 15 to other provisions of the Code that do
not set forth an explicit effective date.
VII. Comments and Changes to Proposed Sec. 1.59A-6--Qualified
Derivative Payments
Proposed Sec. 1.59A-6 provides guidance regarding QDPs.
A. Scope of the QDP Exception
Proposed Sec. 1.59A-6(b) defines a QDP as a payment made by a
taxpayer to a foreign related party pursuant to a derivative with
respect to which the taxpayer (i) recognizes gain or loss as if the
derivative were sold for its fair market value on the last business day
of
[[Page 66995]]
the taxable year (and any additional times as required by the Code or
the taxpayer's method of accounting); (ii) treats any recognized gain
or loss as ordinary; and (iii) treats the character of all items of
income, deduction, gain, or loss with respect to a payment pursuant to
the derivative as ordinary. The definition in the proposed regulations
adopts the statutory definition of a QDP contained in section
59A(h)(2)(A). The QDP exception under the statute and the proposed
regulations is subject to further limitations that are discussed in
Parts VII.B and C of this Summary of Comments and Explanation of
Revisions.
A comment requested that the scope of the QDP definition be
expanded. The comment requested that the final regulations extend the
scope of the QDP exception so that multinational corporations that use
a centralized hedging center structure can benefit from this exception
from the definition of a base erosion payment with respect to their
outbound related-party hedging payments. The comment stated that
taxpayers in the oil and gas sector often do not adopt a mark-to-market
method of tax accounting for a variety of business and tax-related
reasons. The comment recommended that the final regulations adopt a
distinct QDP exception that would be applicable to oil and gas hedging
centers (as well as any similarly situated hedging centers). The
comment requested that this QDP exception exclude related-party hedging
payments from the scope of base erosion payments, without regard to
whether the taxpayer satisfies the requirement in section
59A(h)(2)(A)(i) that the taxpayer accounts for the underlying commodity
derivative on a mark-to-market basis. As an alternative, the comment
suggested that the final regulations could interpret the mark-to-market
requirement of section 59A(h)(2)(A)(i) broadly to cover taxpayers that
undertake mark-to-market accounting for derivatives for either
financial accounting or tax purposes.
For a derivative payment to qualify for the QDP exception, section
59A(h)(2)(A) requires that the taxpayer recognize gain or loss with
respect to the derivative as if the derivative were sold for its fair
market value on the last business day of the taxable year, and ``such
additional times as required by this title or the taxpayer's method of
accounting'' (emphasis added). The Treasury Department and the IRS,
therefore, interpret section 59A as excluding a derivative from the QDP
exception if the taxpayer does not adopt a mark-to-market method of tax
accounting. In light of the statute's clear requirement for the QDP
exception that a derivative must be treated as sold for its fair market
value on the last business day of the taxable year (or more frequently,
if required by the Code or the taxpayer's method of accounting), the
final regulations do not adopt the comment. See Sec. 1.475(a)-4(d).
B. Sale-Repurchase Transactions and Securities Lending Transactions
Section 59A(h)(1) provides that a QDP is not treated as a base
erosion payment. To qualify for the QDP exception, the payment must be
made with respect to a derivative. A derivative is generally defined in
section 59A(h)(4) as any contract the value of which, or any payment or
other transfer with respect to which, is directly or indirectly
determined by reference to one or more listed items, including any
share of stock in a corporation or any evidence of indebtedness. A
derivative does not include any of the listed items. Section 59A(h)(3)
excludes from the QDP exception any payment that would be treated as a
base erosion payment if it were not made pursuant to a derivative (for
example, interest on a debt instrument). Section 59A(h)(3) also
excludes any payment properly allocable to a nonderivative component of
a contract that contains derivative and nonderivative components.
The preamble to the proposed regulations notes that a sale-
repurchase transaction satisfying certain conditions is treated as a
secured loan for U.S. federal tax purposes, and therefore, is not a
derivative. REG-104259-18, 83 FR 65962 (December 21, 2018). The
preamble to the proposed regulations explains that ``[b]ecause sale-
repurchase transactions and securities lending transactions are
economically similar to each other, the Treasury Department and the IRS
have determined that these transactions should be treated similarly for
purposes of section 59A(h)(4), and therefore payments on those
transactions are not treated as QDPs.'' REG-104259-18, 83 FR 65963
(December 21, 2018). As a result, proposed Sec. 1.59A-6(d)(2)(iii)
provides that a derivative does not include any securities lending
transaction, sale-repurchase transaction, or substantially similar
transaction.
Comments generally agreed that a sale-repurchase transaction that
is treated as a secured loan for U.S. federal income tax purposes is
not a derivative; therefore, comments acknowledged that a sale-
repurchase transaction that is treated as a secured loan for U.S.
federal tax purposes is not eligible for the QDP exception under
section 59A, regardless of the specific exclusion language in proposed
Sec. 1.59A-6(d)(2)(iii). Certain comments explained that the nominal
seller of the securities in a sale-repurchase transaction is treated as
transferring the securities as collateral of a loan. Comments interpret
current federal income tax law to provide that the nominal seller
remains the tax owner of the securities when a sale-repurchase
transaction is treated as a secured loan for federal income tax
purposes. Therefore, when the nominal buyer of the securities receives
payments with respect to the collateral securities (for example, in the
case of an equity security, the dividend payments), and passes those
payments on to the nominal seller (or otherwise credits the seller for
the amount of the payments), the comments asserted that the nominal
seller is treated as having directly received those payments from the
issuer of the securities.
In the context of section 59A, if the nominal seller in a sale-
repurchase transaction that is treated as a loan is a domestic
corporation and the nominal buyer is a foreign related party, any
interest paid with respect to the secured loan from the domestic
corporation to the foreign related party would be a base erosion
payment, not a QDP. In a sale-repurchase transaction that is treated as
a loan for which the nominal seller is instead a foreign related party
and the nominal buyer is a domestic corporation, the payments with
respect to the security held by the nominal buyer as collateral for
that transaction are treated as received by the nominal buyer for the
benefit of the nominal seller. Because there is no regarded
``substitute payment'' from the nominal buyer to the nominal seller,
there cannot be a base erosion payment.
Comments asserted that securities lending transactions and sale-
repurchase transactions are treated differently with respect to
underlying payments or substitute payments as a result of proposed
Sec. 1.59A-6(d)(2)(iii) even though the transactions are economically
similar. Comments observed that in a typical fully-collateralized
securities lending transaction, the securities lender transfers the
securities to the securities borrower in exchange for an obligation by
the borrower to make certain payments to the securities lender and
return identical securities. Unlike a sale-repurchase transaction,
comments remarked that this transaction results in a transfer of
beneficial ownership of the securities to the securities borrower for
U.S. federal income tax purposes. Comments noted that these securities
lending transactions may arise in the ordinary course of business, for
example, to facilitate a short sale of the
[[Page 66996]]
underlying security. In connection with the transfer of securities, the
securities borrower provides cash or other collateral to the securities
lender, typically with the same or greater value as the underlying
security. Comments observed that the securities lender in these
transactions can be viewed as both a lender of securities to the
counterparty, and as the borrower of cash from the counterparty.
Comments suggested that the final regulations should treat a
collateralized securities lending transaction as consisting of two
legs: (1) A loan of securities, or a ``securities leg'', and (2) a loan
of cash, or a ``cash leg.'' Comments stated that the cash leg is simply
a cash borrowing by the security lender. Many comments conceded that
the cash leg of a securities lending transaction should not be eligible
for the QDP exception because the cash leg is properly treated as a
loan and any payments should be treated as interest. Certain of these
comments observed that the treatment of the cash leg of a securities
lending transaction as debt giving rise to interest payments is
consistent with the broadly symmetrical treatment of securities lending
transactions and sale-repurchase transactions that are treated as
secured loans for U.S. federal income tax purposes.
Comments, however, asserted that the securities leg of a securities
lending transaction should be treated as a derivative that qualifies
for the QDP exception. The comments argued that a securities leg meets
the statutory requirement of a derivative because it represents a
contract, which includes any short position, the value of which, or any
payment or other transfer with respect to which, is (directly or
indirectly) determined by reference to any share of stock in a
corporation. By treating a substitute payment in a securities lending
transaction as eligible for the QDP exception, those payments would
receive similar treatment for purposes of section 59A as in the case of
a sale-repurchase transaction that is treated as a secured loan. That
is, in the sale-repurchase transaction, the remittances on the
collateral by the nominal buyer to the nominal seller are treated as a
payment from the issuer of the security to the nominal seller for U.S.
federal income tax purposes.
Some comments acknowledged that in certain circumstances, there is
the potential to use a securities lending transaction as a financing.
One comment described a scenario involving an uncollateralized
securities borrowing by a domestic corporation of relatively risk-free
debt, such as short-term Treasury bills, from a foreign related party.
As a second step, the domestic corporation immediately sells the
Treasury bills for cash; after a short period, the taxpayer buys even
shorter-term Treasury bills and redelivers them to the lender. Comments
acknowledged that in this situation, or in similar situations, the
transaction may be viewed as economically equivalent to borrowing
money, with the taxpayer exposed to the relatively small risk of
changes in the value of the security (here, U.S. government-backed
Treasury bills).
Rather than excluding all securities lending transactions from QDP
status, comments generally recommended that the final regulations adopt
rules to address this particular risk. Some comments recommended
adopting a specific operating rule to address this concern, including
(i) providing that only contracts entered into in the ordinary course
of the taxpayer's trade or business can qualify for the QDP exception,
(ii) providing that only fully collateralized transactions can qualify
for the QDP exception, or (iii) applying different rules for securities
lending transactions involving relatively low-risk securities (such as
Treasury bills) than for other securities that are subject to more
market risk. Regarding fully collateralized securities lending
transactions, some comments asserted that under certain bank regulatory
regimes, other amounts outside of the actual collateral in the
transaction may effectively serve as collateral due to the securities
borrower's compliance with any specific regulatory regime governing
securities borrowing. Some comments recommended that the final
regulations adopt an anti-abuse rule rather than an operating rule to
address this concern. One comment suggested an anti-abuse rule that
excludes from the QDP exception transactions with specific debt-like
features that make the transaction substantially similar to a
financing, while another comment noted that it would be unduly
burdensome to test contracts based on certain characteristics,
particularly for taxpayers that engage in a high volume of these
transactions in the ordinary course. This comment instead suggested
that all securities lending transactions entered into for valid non-tax
business purposes should be eligible for the QDP exception.
In response to these comments, the final regulations make certain
revisions to Sec. 1.59A-6(d)(2)(iii). First, Sec. 1.59A-6(d)(2)(iii)
has been revised to more directly provide that a derivative contract as
defined in section 59A(h)(4) does not include a sale-repurchase
transaction or substantially similar transaction that is treated as a
secured loan for U.S. federal income tax purposes. Second, Sec. 1.59A-
6(d)(2)(iii) is also revised to exclude from the definition of a
derivative for purposes of section 59A(h) the cash leg of a securities
lending transaction, along with cash payments pursuant to a sale-
repurchase transaction, or other similar transaction. The final
regulations no longer expressly exclude securities lending transactions
from the definition of a derivative contract in Sec. 1.59A-
6(d)(2)(iii). As a result, payments (such as a borrow fee) made with
respect to the securities leg of a securities lending transaction may
qualify as a QDP.
To address the concern about securities lending transactions that
have a significant financing component, the final regulations adopt the
recommendation from comments to provide an anti-abuse rule. See Sec.
1.59A-6(d)(2)(iii)(C). The anti-abuse rule in the final regulations
includes criteria to limit the rule to situations that have been
identified as presenting clear opportunities for abuse. The anti-abuse
rule takes into account two factors: (a) Whether the securities lending
transaction or substantially similar transaction provides the taxpayer
with the economic equivalent of a substantially unsecured cash
borrowing and (b) whether the transaction is part of an arrangement
that has been entered into with a principal purpose of avoiding the
treatment of any payment with respect to the transaction as a base
erosion payment. The determination of whether a securities lending
transaction or substantially similar transaction provides the taxpayer
with the economic equivalent of a substantially unsecured cash
borrowing takes into account arrangements that effectively serve as
collateral due to the taxpayer's compliance with any U.S. regulatory
requirements governing such transaction. The anti-abuse rule is based
on these factors because the Treasury Department and the IRS are
cognizant that an objective mechanical rule based on the level of
collateralization may be difficult for both taxpayers and the IRS to
apply, in particular due to the high volume of transactions issued
under varying conditions.
C. QDP Reporting Requirements
Section 59A(h)(2)(B) provides that no payment is a QDP for a
taxable year ``unless the taxpayer includes in the information required
to be reported under section 6038B(b)(2) \4\ [sic] with
[[Page 66997]]
respect to such taxable year such information as is necessary to
identify the payments to be so treated and such other information as
the Secretary determines necessary to carry out the provisions of this
subsection.'' Proposed Sec. 1.59A-6(b)(2)(i) clarifies that no payment
is a QDP unless the taxpayer reports the information required by the
Secretary in proposed Sec. 1.6038A-2(b)(7)(ix). Proposed Sec.
1.6038A-2(b)(7)(ix) identifies the specific information that a taxpayer
needs to report to comply with the reporting requirement of section
59A(h)(2)(B) and proposed Sec. 1.59A-6(b)(2)(i). The proposed
regulations provide that the rule for reporting QDPs applies to taxable
years beginning one year after final regulations are published in the
Federal Register. Proposed Sec. 1.6038A-2(g). Before proposed Sec.
1.6038A-2(b)(7)(ix) is applicable, a taxpayer is treated as complying
with the QDP reporting requirement by reporting the aggregate amount of
QDPs on Form 8991. Id.
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\4\ As enacted, section 59A(h)(2)(B) cross-references section
6038B(b)(2). This cross-reference in section 59A(h)(2)(B) is a
typographical error. Section 6038B(b)(2) does not relate to section
59A. The correct cross-reference is to section 6038A(b)(2). The Act
added reporting requirements for section 59A in section 6038A(b)(2).
See Act, Sec. 14401(b).
---------------------------------------------------------------------------
1. Scope of QDP Reporting
Section 1.6038A-1(c) generally defines a reporting corporation as
either a domestic corporation that is 25-percent foreign-owned, or a
foreign corporation that is 25-percent foreign-owned and engaged in
trade or business within the United States. A comment recommended that
the final regulations clarify that a failure to comply with the Form
8991 reporting requirements by a taxpayer that is not a reporting
corporation (within the meaning of Sec. 1.6038A-1(c)) does not affect
the QDP status of any payments made by the taxpayer. The comment also
recommended that the final regulations clarify the consequences of
failing to comply with the Form 8991 QDP reporting requirements.
Section 59A(h)(2)(B) requires that all taxpayers, whether or not
the taxpayer is a reporting corporation within the meaning of section
6038A, report QDPs in order for the exception to apply to any
particular payment. The Treasury Department and the IRS interpret the
language in section 59A(h)(2)(B) referencing section 6038B(b)(2) (``the
information required to be reported under section 6038B(b)(2) [sic]'')
as addressing the scope of information required to be reported rather
than limiting the scope of taxpayers that must report in order to
qualify derivatives as QDPs under section 59A(h). The final
regulations, therefore, clarify that Sec. 1.59A-6(b)(2)(i) applies to
all taxpayers (whether or not a taxpayer is a reporting corporation as
defined in Sec. 1.6038A-1(c)) and that all taxpayers must report the
information required by Sec. 1.6038A-2(b)(7)(ix) for a payment to be
eligible for QDP status.
Comments also requested additional guidance regarding the
consequences when a taxpayer fails to comply with the QDP reporting
requirements with respect to a particular payment. The proposed
regulations provide that a failure by a taxpayer to report a particular
payment as a QDP disqualifies only that payment and does not affect the
taxpayer's properly reported payments. The final regulations retain
that rule. In addition, Sec. 1.59A-6(b)(2)(i) provides that a taxpayer
satisfies the reporting requirement by including a QDP in the aggregate
amount of all QDPs (rather than the aggregate amount as determined by
type of derivative contract as provided in proposed Sec. 1.6038A-
2(b)(7)(ix)(A)) on Form 8991 or a successor form.
Another comment requested a reasonable cause exception to the QDP
reporting requirements because treating a payment as a base erosion
payment solely when a taxpayer failed to report the payments as a QDP
would unfairly penalize a taxpayer for making an error. The Treasury
Department and the IRS have determined that a reasonable cause
exception is inappropriate because section 59A(h)(2)(B) provides that a
taxpayer must identify all base erosion payments. A taxpayer must
determine that a payment is eligible for the QDP exception and,
therefore, properly excluded from the base erosion percentage
calculation. Similarly, a taxpayer must determine that a payment is
properly characterized as a QDP to properly determine modified taxable
income for purposes of section 59A. In addition, a reasonable cause
exception would make it more difficult for the IRS to administer
section 59A. However, as discussed in Part VII.C.3 of this Summary of
Comments and Explanation of Revisions, the final regulations provide a
good faith standard that applies during the QDP transition period
before the reporting set forth in Sec. 1.6038A-2(b)(7)(ix) is
required. In addition, in response to comments, the transition period
has been extended to 18 months.
2. Determining the Amount of QDP Payment
A comment recommended that the final regulations clarify that
taxpayers may use the net amount with respect to each derivative
transaction to arrive at the aggregate QDP amount that must be reported
on Form 8991. The comment noted that this approach would be consistent
with the BEAT Netting Rule for mark-to-market transactions. See Part
III.D of Summary of Comments and Explanation of Revisions. Generally,
the Treasury Department and the IRS have adopted this comment. See
Sec. 1.59A-6(b)(2)(iii). A taxpayer, however, must exclude from the
net amount of a QDP any payment made with respect to a derivative that
is either excluded from QDP status pursuant to section 59A9(h)(3) or
otherwise treated as a type of payment that is not a derivative
payment. See Sec. 1.59A-6(b)(3)(ii).
Another comment requested excluding from QDP reporting requirements
any payments with respect to securities lending transactions and sale-
repurchase transactions that are not regarded under generally accepted
accounting principles (GAAP). The final regulations do not adopt this
recommendation. Reporting QDPs is a statutory requirement to provide
the IRS with data about transactions that have been excluded under the
QDP exception, and the financial accounting for these transactions is
not relevant to QDP status. Furthermore, the Treasury Department and
the IRS have determined that the deferred applicability date and
transition period, described in Part VII.C.3 of Summary of Comments and
Explanation of Revisions, will provide taxpayers with adequate time to
develop systems to track the information that may not have been
previously maintained in accounting systems.
3. Applicability Date and Transition Period for QDP Reporting
Comments asserted that taxpayers needed additional time before the
final regulations regarding QDP reporting are applicable. Comments
noted that before the enactment of section 59A, taxpayers generally
were not required to separately track or account for certain
transactions with foreign related parties. The Treasury Department and
the IRS recognize that section 59A will require taxpayers to develop
new systems to properly report QDPs; therefore, the final regulations
extend the transition period for meeting the complete QDP reporting
requirements until taxable years beginning Monday, June 7, 2021.
Another comment requested additional guidance regarding the QDP
reporting requirements that apply before the applicability date of the
final regulations for these rules (the ``QDP transition period'').
Specifically,
[[Page 66998]]
comments interpreted the QDP transition period as applying only to a
reporting corporation as defined in Sec. 1.6038A-1(c). They
recommended that all taxpayers be permitted to report QDPs on an
aggregate basis during the QDP transition period and that the good
faith effort standard for reporting QDPs during the transition period
should apply to all taxpayers. The final regulations adopt these
comments by clarifying that Sec. 1.6038A-2(b)(7)(ix) applies to a
taxpayer whether or not the taxpayer is a reporting corporation as
defined in Sec. 6038A-1(c). See Sec. 1.59A-6(b)(2)(i). In addition,
the final regulations eliminate the rule in the proposed regulations
requiring a taxpayer to report the aggregate amount of QDPs as
determined by type of derivative contract, the identity of each
counterparty, and the aggregate amount of QDPs made to each
counterparty. The Treasury Department and the IRS anticipate that the
aggregate amount of QDPs provides adequate information to allow the IRS
to administer the QDP rules.
VIII. Comments and Changes to Proposed Sec. 1.59A-7--Application of
BEAT to Partnerships
Proposed Sec. 1.59A-7 provides rules regarding how partnerships
and their partners are treated for purposes of the BEAT. The proposed
regulations generally apply an aggregate approach in addressing the
treatment of payments made by a partnership or received by a
partnership for purposes of section 59A.
A. Partnership Contributions and Distributions
1. Request for Contribution Exception
The proposed regulations treat a contribution to a partnership as a
transaction between the partners that may result in a base erosion
payment, including when a partnership with a domestic corporate partner
receives a contribution of depreciable property from a foreign related
party. Several comments requested a change to the approach taken in the
proposed regulations. One comment asserted that the issuance of a
partnership interest in exchange for a contribution to a partnership
was not intended to be a base erosion payment covered by section
59A(d)(2) and that subjecting inbound nonrecognition transactions to
the BEAT seems contrary to the purpose of the Act, which the comment
stated was to encourage taxpayers to relocate business functions and
assets to the United States and expand business activities in the
United States. The comment noted that if Congress intended to subject
nonrecognition transactions to the BEAT, it would have done so more
explicitly.
Other comments generally asserted that nonrecognition transactions
should not be subject to the BEAT. Some of these comments specifically
addressed section 721 transactions and recommended that the same
exception for section 351 transactions that is discussed in Part IV.B.3
of this Summary of Comments and Explanation of Revisions apply to
section 721(a) transactions.
In contrast, a comment noted that applying an aggregate approach to
partnerships for purposes of the BEAT was consistent with the purposes
of the statute. The comment asserted that treating a contribution of
property in exchange for a partnership interest as a potential base
erosion payment is consistent with the concept of treating a
partnership as an aggregate of its partners and with the purposes of
section 59A. The comment explained that to the extent there is a base
eroding transaction when property (such as depreciable property) is
contributed to a partnership under section 721, it is the acquisition
of a proportionate share of new property by the existing partners from
a contributing partner (assuming that partner is a foreign related
party). The comment also explained that the existing partners would
have paid for the new property with a proportionate share of the
existing assets of the partnership. In addition, the comment noted that
a contributing partner (such as a domestic corporation) could be
acquiring a proportionate share of the partnership's existing assets
(where one or more partners of the partnership are foreign related
parties).
The final regulations do not adopt the comments requesting an
exception for nonrecognition transactions involving partnerships. The
general premise of the aggregate approach to transactions involving
partners and partnerships in both the proposed regulations and the
final regulations is to treat partners as engaging in transactions
directly with each other, not as engaging in transactions with the
partnership as a separate entity (solely for purposes of section 59A).
See Sec. 1.59A-7(b) and (c); proposed Sec. 1.59A-7(b)(1)-(3); REG-
104259-18, 83 FR 65965 (December 21, 2018). The Treasury Department and
the IRS acknowledge that the final regulations include an exception for
specified corporate nonrecognition transactions that is discussed in
Part IV.B.3 of the Summary of Comments and Explanation of Revisions,
which presents some similarity with the types of transactions
contemplated by this comment. For example, if a domestic corporation
and a foreign related party each contribute depreciable property to a
new domestic corporation in exchange for stock of the new domestic
corporation in a transaction that qualifies under section 351(a), the
new domestic corporation generally will not be treated as making a base
erosion payment in exchange for the depreciable property pursuant to
the new exception in the final regulations for specified corporate
nonrecognition transactions that is discussed in Part IV.B.3 of the
Summary of Comments and Explanation of Revisions. In contrast, if the
same domestic corporation and a foreign related party each contribute
depreciable property to a new partnership in exchange for interests in
the partnership in a transaction that qualifies under section 721(a),
the transaction is treated as a partner-to-partner exchange that may
result in a base erosion payment solely for purposes of section 59A,
with no specific exception adopted in the final regulations.
The final regulations do not extend the exception for specified
corporate nonrecognition transactions to partnership transactions
because that treatment would be generally inconsistent with the
approach of treating partners in a partnership as engaging in
transactions with each other. The preamble to the proposed regulations
states that the Treasury Department and the IRS determined that a rule
that applies the aggregate principle consistently is necessary to align
the treatment of economically similar transactions. REG-104259-18, 83
FR 65956, 65967 (Dec. 21, 2018).
The adoption of a section 721(a) exception to the BEAT could permit
related parties to use a partnership to avoid a transaction that would
be a base erosion payment if that transaction occurred directly among
the partners. The Treasury Department and the IRS acknowledge that in
some respects, a similar argument could be made against adopting the
exception for specified corporate nonrecognition transactions that
applies to the section 351(a) example that is described in this Part
VIII.A.1; however, the general tax rules that apply to corporations
under subchapter C are fundamentally different from the general tax
rules that apply to partnerships under subchapter K. In particular,
when property is distributed by a partnership back to the partner,
nonrecognition by the partnership and the partner is the general rule
under subchapter K; however, when property is distributed by a
corporation back to its shareholder,
[[Page 66999]]
recognition and income by the corporation and the shareholder is the
general rule under subchapter C. Compare sections 731(b) and (a) with
sections 311(b) and 301(c). For these reasons, the final regulations do
not extend the exception that is provided to specified corporate
nonrecognition transactions to partnership nonrecognition transactions,
such as contributions.
2. Amounts Paid or Accrued
Proposed Sec. 1.59A-3(b)(2)(i) confirms that an amount ``paid or
accrued,'' as those terms are used for purposes of determining whether
there is a base erosion payment, includes an amount paid or accrued
using any form of consideration.
A comment asserted that subchapter K of the Code contains well-
developed provisions to distinguish between a sale or exchange, as
opposed to a contribution, and that there should only be a ``payment or
accrual'' for purposes of section 59A(d) to the extent a partner is
treated as receiving proceeds from the partnership pursuant to a sale
(for example, under the disguised sale rules of section 707).
Similarly, a comment recommended that a distribution by a partnership
described in section 731 generally not be treated as an amount paid or
accrued for purposes of section 59A, except to the extent that the
transaction would be treated as a deemed sale of property by the
partnership.
In addition, one comment recommended that if the final regulations
continue to treat certain partnership contributions and distributions
as ``payments'' that could be base erosion payments, the applicability
date of the provisions relating to this treatment should be modified to
take into account that taxpayers have engaged in contributions to (or
distributions by) partnerships between December 31, 2017, and December
21, 2018, without guidance that these transactions could be treated as
base erosion payments. The comment also recommended a special rule to
exclude pro-rata contributions (contributions made by each partner of
the partnership in proportion to its interest in the partnership) from
the definition of ``an amount paid or accrued.''
The final regulations continue to treat contributions to and
distributions from partnerships as ``payments'' that could be base
erosion payments under the aggregate approach. Section 59A does not
contain an explicit restriction on the type of consideration that
constitutes a payment. Proposed Sec. 1.59A-3(b)(2)(i) confirms that
``an amount paid or accrued includes an amount paid or accrued using
any form of consideration, including cash, property, stock, or the
assumption of a liability.'' The final regulations include the same
language. The Treasury Department and the IRS have determined that it
is not appropriate to change the operating rule describing payment
consideration or delay its application. However, in response to
comments, the final regulations add partnership interests to the non-
exclusive list of examples of consideration in Sec. 1.59A-3(b)(2)(ii)
to reaffirm this result.
The final regulations do not exclude pro-rata contributions from
the definition of ``an amount paid or accrued'' and therefore, they are
not excluded from the definition of a base erosion payment. If pro-rata
contributions are made by each partner, each transaction must be
separately considered, consistent with the general rule in section 59A
that assesses transactions on a gross, rather than net, basis. A pro-
rata contribution exclusion would be inconsistent with the aggregate
approach taken in these final regulations. For example, if there was an
exception, a domestic corporation could contribute cash to a new
partnership and its foreign parent could contribute depreciable
property, each in proportion to their interest in the partnership, and
under the exception, the transaction would not be subject to section
59A even though, under the aggregate approach, the domestic corporation
effectively acquired its proportionate share of the contributed
depreciable property from a foreign related party in exchange for cash.
See also Part VIII.B of this Summary of Comments and Explanation of
Revisions (Netting). To clarify this point, Sec. 1.59A-7(c)(5)(iv)
provides that when both parties to a transaction use non-cash
consideration, each party must separately determine its base erosion
payment with respect to each property, and Sec. 1.59A-7(d)(1) provides
that base erosion tax benefits are calculated separately for each
payment or accrual on a property-by-property basis and are not netted.
Consistent with the approach taken for contributions to a
partnership, the Treasury Department and the IRS determined that no
special rule should be provided for distributions by a partnership. The
approach suggested by a comment--only treating distributions subject to
the disguised sales rules as potential base erosion payments--would be
inconsistent with the aggregate approach to partnerships for the
reasons discussed in the context of partnership contributions.
3. Request for ECI Exception
A comment recommended that contributions of depreciable (or
amortizable) property by a foreign related party to a partnership (in
which an applicable taxpayer is a partner) or distributions of
depreciable or amortizable property by a partnership (in which a
foreign related party is a partner) to an applicable taxpayer be
excluded from the definition of a base erosion payment to the extent
that the foreign related party would receive (or would be expected to
receive) allocations of income from that partnership interest that
would be taxable to the foreign related party as effectively connected
income. The final regulations do not include rules relating to these
comments. In the 2019 proposed regulations, however, the Treasury
Department and the IRS request comments regarding how to address a
contribution by a foreign person to a partnership engaged in a U.S.
trade or business, transfers of partnership interests by a foreign
person, and transfers of property by the partnership with a foreign
person as a partner to a related U.S. person. See Part VI.B of the
Explanation of Provisions of the preamble to the 2019 proposed
regulations in which the Treasury Department and the IRS request
comments regarding transactions involving partners and partnerships
that have effectively connected income.
B. Netting
Proposed Sec. 1.59A-3(b)(2)(iii) provides that the amount of any
base erosion payment is determined on a gross basis unless the
transaction is subject to a special mark-to-market rule or the Code or
regulations otherwise provide. A comment requested that a special
netting rule be provided for partnerships when the base erosion tax
benefits allocated by a partnership are reduced by deductions foregone
as a result of the partner contributing property to the partnership.
The Treasury Department and the IRS have determined that this
suggestion is inconsistent with the gross basis regime generally. See
Part IV.A.3 of this Summary of Comments and Explanation of Revisions
(Netting). The result addressed in the comment is the same result that
would arise if the transactions had occurred outside of a partnership.
For example, a taxpayer that acquired one depreciable asset from a
foreign related party and sold another asset would be in a similar
position: the taxpayer would treat the depreciation with respect to the
acquired asset as a base erosion tax benefit and there would
[[Page 67000]]
be no offset for deductions from the asset the taxpayer sold (even if
those ``foregone'' deductions would not have been base erosion tax
benefits). Section 1.59A-7(d)(1) clarifies that base erosion tax
benefits are determined separately for each asset, payment, or accrual,
as applicable, and are not netted with other items.
C. Aggregate Approach to Ownership of Partnership Assets
Proposed Sec. 1.59A-7(b)(5)(i) provides that (subject to the small
partner exception), for purposes of section 59A, each partner is
treated as owning its share of the partnership items determined under
section 704, including the assets of the partnership, using a
reasonable method with respect to the assets. A comment proposed either
removing the phrase ``including the assets of the partnership'' from
this rule or including examples that clarify the purposes of section
59A for which the aggregate approach to the ownership of partnership
assets is relevant.
In response to this comment, the final regulations remove this
language from Sec. 1.59A-7(b)(5)(i). Instead, when it is necessary for
a person to determine what assets were transferred from or to a partner
in a partnership, the relevant provision refers to the partner's
proportionate share of the assets, as determined based on all of the
facts and circumstances. See Sec. 1.59A-7(c)(2), (3), and (4).
D. Determining the Base Erosion Payment
Proposed Sec. 1.59A-7(b) generally provides that section 59A is
applied at the partner level and that amounts paid or accrued by (or
to) a partnership are treated as paid or accrued by (or to) the
partners based on their distributive shares.
A number of comments requested clarification with respect to the
aggregate approach taken in the proposed regulations. For example, a
comment indicated that the proposed regulations do not address how to
determine each partner's share of a payment received by a partnership
if the payment results in no income or gain or results in a deduction
or loss (for example, where a partnership sells depreciable or
amortizable property to an applicable taxpayer and the amount realized
is equal to or less than the partnership's adjusted basis in the
property). The comment recommended that the final regulations provide
rules for determining the extent to which a partner is treated as
receiving a payment received by a partnership where the payment results
in no income or a deduction or loss. The comment suggested that
taxpayers be permitted to use a reasonable method to determine each
partner's share of a payment received by the partnership if the payment
results in no income and that, in circumstances where a payment results
in a deduction or loss, the partner's share of the payment be
determined by the partner's share of the deduction or loss.
Additionally, the comment suggested that the final regulations permit
taxpayers to use a reasonable method to determine each partner's share
of the payment received by the partnership where the income or gain is
recognized over multiple taxable years (such as in an installment
sale).
Comments also requested that the final regulations clarify that
depreciation deductions allocated to a taxpayer by a partnership that
are attributable to property contributed to the partnership by a
foreign related party are not treated as base erosion tax benefits if
the property was contributed before the effective date of the BEAT.
One comment requested clarification regarding a scenario described
in the preamble in which a foreign related party and a taxpayer form a
partnership, and the foreign related party contributes depreciable
property to the partnership. The preamble concludes that deductions for
depreciation of the property contributed generally are base erosion tax
benefits because the partnership is treated as acquiring the property
in exchange for an interest in the partnership under section 721(a).
REG-104259-18, 83 FR 65956, 65967 (Dec. 21, 2018). The comment
requested that the final regulations clarify whether, in the scenario
described in the preamble, each partner is treated as making its share
of the payment (in the form of an interest in the partnership) to the
foreign related party contributing the depreciable property under
proposed Sec. 1.59A-7(b)(2) in determining if there is a base erosion
payment. The language in the preamble to the proposed regulations that
the comment discussed was in error. Consistent with the aggregate
approach, the language should have stated that the deductions for
depreciation of the property contributed generally are base erosion tax
benefits because the other partners are treated as acquiring the
property in exchange for a portion of their interest in the partnership
assets, and this is clarified in the final regulations. See Sec.
1.59A-7(c)(3).
In response to the comments, the final regulations provide a more
detailed explanation of how the aggregate approach set forth in the
proposed regulations operates, including the treatment of partnership
contributions and transfers of partnership interests (including
issuances). In addition, Sec. 1.59A-7(g) includes examples
illustrating the application of the rules.
The final regulations clarify that if property described in Sec.
1.59A-3(b)(1)(ii) or (iv) (depreciable or amortizable property or
property that results in reductions to determine gross income) is
transferred to a partnership, each partner is treated as receiving its
proportionate share of the property for purposes of determining if it
has a base erosion payment. Similarly, if the partnership transfers
property described in Sec. 1.59A-3(b)(1)(ii) or (iv), each partner is
treated as transferring its proportionate share of the property for
purposes of determining if the recipient has a base erosion payment.
See Sec. 1.59A-7(c)(2). If a partnership interest is transferred
(other than by a partnership), the transferor generally is treated as
transferring its proportionate share of the partnership's assets. When
a partnership interest is transferred by a partnership, each partner
whose proportionate share of assets is reduced is treated as
transferring the amount of the reduction. See Sec. 1.59A-7(c)(3).
In keeping with this construct, if a taxpayer was a partner in a
partnership and a foreign related party contributed depreciable
property to the partnership before January 1, 2018, there would be no
base erosion payment. However, also consistent with this construct, if
a taxpayer acquires an interest (including an increased interest) in
any partnership asset (including pursuant to a transfer of a
partnership interest either by the partnership or by another person) on
or after January 1, 2018, from a partnership that holds depreciable
property and has a foreign related party as a partner whose interest in
the asset is reduced, with or without a section 754 election by the
partnership, that transaction will be a base erosion payment because
the property will be treated as acquired on or after January 1, 2018.
See Sec. 1.59A-7(c).
The final regulations also clarify that the amount of deduction
resulting from a payment is not impacted by the gain or loss arising
from the consideration used to make the payment. Therefore, if the
partnership makes a payment, that payment from the partnership may
result in a deduction even if the partnership incurs a gain on the
transfer under general tax principles because the partnership used
built-in gain property as consideration. Similarly, if the partnership
receives a payment as consideration for the sale of built-in loss
property, that payment to the partnership will result in income. See
[[Page 67001]]
Sec. 1.59A-3(b)(2)(ix) and Sec. 1.59A-7(c)(5)(iv) and (d)(1).
If a series of payments or accruals with respect to a transaction
occurs over time, whether there is a base erosion payment is determined
each time there is a payment or accrual. If, instead, there is a single
payment that results in base erosion tax benefits being allocated by a
partnership over multiple years, the portion of the payment that is a
base erosion payment must be determined at the time of the payment, but
the amount of the base erosion tax benefits will be determined based on
the allocations by the partnership that occur each year. For example,
if a partnership, whose partners are a domestic corporation and an
unrelated person, acquires depreciable property from a foreign related
party of the domestic corporation, then the entire amount is a base
erosion payment with respect to the domestic corporation and any
allocations by the partnership of depreciation to the domestic
corporation are base erosion tax benefits.
The final regulations clarify that if a distribution of property
from a partnership to a partner causes an increase in the tax basis of
property that either continues to be held by the partnership or is
distributed from the partnership to a partner, such as under section
732(b) or 734(b), the increase in tax basis for the benefit of a
taxpayer that is attributable to a foreign related party is treated as
if it was newly purchased property by the taxpayer from the foreign
related party that is placed in service when the distribution occurs
for purposes of determining if a taxpayer has a base erosion payment.
See Sec. 1.59A-7(c)(4).
The final regulations also include certain additional operating
rules to clarify how Sec. 1.59A-7 applies. For example, Sec. 1.59A-
7(c)(5)(ii) clarifies the order in which the base erosion payment rules
apply, and Sec. 1.59A-7(c)(5)(iv) reaffirms that if both parties to a
transaction use non-cash consideration, each transfer of property must
be separately analyzed to determine if there is a base erosion payment.
The final regulations also clarify that if a transaction is not
specifically described in Sec. 1.59A-7, whether it gives rise to a
base erosion payment or base erosion tax benefit will be determined in
accordance with the principles of Sec. 1.59A-7 and the purposes of
section 59A. See Sec. 1.59A-7(b). Further, the final regulations
clarify that the aggregate approach under Sec. 1.59A-7 does not
override the treatment of any partnership item under any Code section
other than section 59A. See Sec. 1.59A-7(a). That clarification is
consistent with the principle that a rule of general applicability
applies unless explicitly replaced or turned off by another rule. Thus,
for example, section 482 continues to apply to controlled transactions
involving partnerships (such as transfers of property or provisions of
services, contributions, and distributions), as it applies to all
controlled transactions, and is taken into account in determining the
arm's length consideration for such transactions (such as the pricing
of transferred property or services, and the valuation of contributions
and distributions) and in determining whether partnership transactions
(including partnership allocations) otherwise clearly reflect income.
See, for example, Sec. Sec. 1.482-1(f)(1)(iii) and (i)(7) and (8) and
1.704-1(b)(1)(iii) and (5)(Ex. 28); Notice 2015-54, 2015-34 I.R.B. 210,
Sec. Sec. 2.03 and 2.04.
Given the absence in the statute of a provision describing the
specific treatment of partnerships and partners, the Act's legislative
history, and the overall significance of the proper functioning of the
BEAT regime, the Treasury Department and the IRS have determined that,
in addition to section 59A, certain authorities in subchapter K provide
support for the treatment of partners and partnerships under these
final regulations. The 1954 legislative history to subchapter K makes
clear that this determination of aggregate versus entity should be
based on the policies of the provision at issue, in this case, section
59A. See H.R. Rep. No. 83-2543, at 59 (1954). Under the rules of
subchapter K, an aggregate approach applies if it is appropriate to
carry out the purpose of a provision of the Code, unless an entity
approach is specifically prescribed and clearly contemplated by the
relevant statute. See, for example, Sec. 1.701-2(e). The BEAT regime
does not prescribe the treatment of a partnership as an entity and the
treatment of a partnership as an aggregate is appropriate with respect
to payments made to or received by it.
E. Determining a Partner's Base Erosion Tax Benefit
For purposes of determining whether a payment or accrual by a
partnership is a base erosion payment, proposed Sec. 1.59A-7(b)(2)
provides that (subject to the small partner exception) any amount paid
or accrued by a partnership is treated as paid or accrued by each
partner based on the partner's distributive share of items of deduction
(or other amounts that could be base erosion tax benefits) with respect
to that amount (as determined under section 704). A comment noted that
proposed Sec. 1.59A-7(b)(2) does not indicate how a partner's base
erosion tax benefits would be determined if a partner's distributive
share of the partnership item that produces the base erosion tax
benefits changed from one taxable year to another taxable year. The
comment concluded that the amount of a partner's distributive share of
deductions with respect to property acquired by the partner's base
erosion payment that is treated as a base erosion tax benefit may not
correspond to the amount of the partner's initial base erosion payment
with respect to that property. The comment recommended that the final
regulations clarify whether any amount of the partner's distributive
share of deductions with respect to property acquired by a base erosion
payment (in any amount) that is treated as made by the partner would be
a base erosion tax benefit, subject to the small partner exception.
Another comment requested that the final regulations provide that
when depreciable property is contributed to a partnership that adopts
the remedial method under Sec. 1.704-3(d) with respect to that
property, the remedial items of depreciation (which may be allocated to
a partner that is an applicable taxpayer) should not be treated as base
erosion tax benefits. The comment further asserted that treating
remedial items as base erosion tax benefits would penalize applicable
taxpayers that are U.S. transferors in section 721(c) partnerships for
which the gain deferral method is applied. See generally Sec.
1.721(c)-1T.
As recommended by a comment, Sec. 1.59A-7(d)(1) clarifies that the
base erosion tax benefits are not dependent on the amount of the base
erosion payment, and provides that a partner's base erosion tax
benefits are the partner's distributive share of any deductions
described in Sec. 1.59A-3(c)(1)(i) or (ii) or reductions to determine
gross income described in Sec. 1.59A-3(c)(1)(iii) or (iv) attributable
to the base erosion payment.
The final regulations also clarify that a taxpayer's base erosion
tax benefits resulting from a base erosion payment include the
partner's distributive share of any deduction or reduction to determine
gross income attributable to the base erosion payment, including as a
result of section 704(c), section 734(b), section 743(b) or certain
other sections. See Sec. 1.59A-7(d)(1). As a result, if a taxpayer is
allocated depreciation or amortization deductions from property
acquired pursuant to a base erosion payment, those deductions are base
[[Page 67002]]
erosion tax benefits. If the partner obtains depreciation deductions in
excess of the partner's proportionate share of the depreciable
property, those deductions still arise from the acquisition of the
property pursuant to a base erosion payment, and the Treasury
Department and the IRS have determined that it would not be appropriate
to exclude those deductions from base erosion tax benefit treatment.
F. Small Partner Exception
The proposed regulations provide that partners with certain small
ownership interests are excluded from the aggregate approach for
purposes of determining base erosion tax benefits from the partnership.
This small partner exception generally applies to partnership interests
that: (i) Represent less than ten percent of the capital and profits of
the partnership; (ii) represent less than ten percent of each item of
income, gain, loss, deduction, and credit; and (iii) have a fair market
value of less than $25 million.
Comments recommended expanding the thresholds for the small partner
exception for partnership interests and items to 25 percent, and
eliminating the fair market value limitation. The comments suggested
that the compliance burden associated with the thresholds in the
proposed regulations would be substantial and that minority partners
may have little or no ability to obtain the necessary information from
the partnership.
The final regulations do not adopt these recommendations. In
determining the appropriate threshold for a small ownership interest in
the proposed regulations, the Treasury Department and the IRS
considered the treatment of small ownership interests in partnerships
in analogous situations in other Treasury regulations. Further, the
fair market value threshold addresses a concern that while a partner
may have a relatively small interest in a partnership, the partnership
itself could have significant value such that partnership items should
not be excluded from the BEAT base when an analogous payment made
outside of the partnership context is not similarly excluded from the
BEAT base. The $25 million fair market value threshold was developed
after qualitative consideration of these factors.
Comments also recommended that the small partner exception apply to
payments made to a partnership. The final regulations do not adopt this
recommendation. The proposed regulations included the small partner
interest exception for payments by a partnership in part because the
Treasury Department and the IRS were cognizant that small partners in a
partnership may not always have sufficient information about the
amounts of payments made by the partnership and the identity of the
payee. The Treasury Department and the IRS were also cognizant that
this type of information is not currently reportable by the partnership
to its partners on a Form K-1; that is, without information provided by
the partnership to the taxpayer partner, that partner may not be able
to determine whether it is treated as having made a base erosion
payment through the partnership pursuant to proposed Sec. 1.59A-7. The
Treasury Department and the IRS considered these factors, and reached a
qualitative conclusion that at or below the threshold level set forth
in the proposed regulations, the administrability considerations
outweighed the competing consideration of ensuring that base erosion
payments through a partnership are properly taken into account by
taxpayer partners in the partnership.
In a situation where a taxpayer makes a payment to a partnership
(that is, a payment that may be a base erosion payment under proposed
Sec. 1.59A-7 because a partner in the partnership is a foreign related
party with respect to the payor), the administrability concerns that
factored into the small partner exception for payments by a partnership
are less pronounced. That is, the taxpayer (payor) will generally have
information to determine whether it has made a payment to a partnership
in which any foreign related party is a partner without needing to
obtain significant information from the partnership. Based on these
factors, the Treasury Department and the IRS reached a qualitative
conclusion that the administrability aspects of accounting for payments
by a taxpayer to a partnership are not outweighed by the competing
consideration of ensuring that base erosion payments to a partnership
are properly taken into account by taxpayer payors.
IX. Comments and Changes to Proposed Sec. 1.59A-9--Anti-Abuse and
Recharacterization Rules
Proposed Sec. 1.59A-9 contains anti-abuse rules that
recharacterize certain transactions in accordance with their substance
for purposes of carrying out the provisions of section 59A. The
proposed anti-abuse rules address the following types of transactions:
(a) Transactions involving intermediaries acting as a conduit if there
is a principal purpose of avoiding a base erosion payment (or reducing
the amount of a base erosion payment); (b) transactions with a
principal purpose of increasing the deductions taken into account in
the denominator of the base erosion percentage; and (c) transactions
among related parties entered into with a principal purpose of avoiding
the application of rules applicable to banks and registered securities
dealers (for example, causing a bank or registered securities dealer to
disaffiliate from an affiliated group so as to avoid the requirement th
at it be a member of such a group).
Comments generally requested more guidance on when a transaction
has ``a principal purpose'' of avoiding a provision of section 59A.
Comments expressed a concern that any transaction that would result in
a lower BEAT liability could be viewed as having ``a principal
purpose'' of avoiding a provision of the section 59A regulations.
Comments also expressed a concern that the anti-abuse rules could be
interpreted as applying to transactions undertaken in the ordinary
course of a taxpayer's business. One comment requested that the
Treasury Department and the IRS consider whether existing anti-abuse
rules and judicial doctrines, including section 7701(o), are sufficient
to address abuse of section 59A.
Consistent with the grant of authority in section 59A(i), the
Treasury Department and the IRS believe that anti-abuse rules specific
to section 59A are needed. The final regulations address the requests
for clarity regarding the ``principal purpose'' standard in the final
regulations by adding new examples that illustrate the differences
between transactions that the Treasury Department and the IRS find to
be abusive or non-abusive. See Sec. 1.59A-9(c)(5), (7), (8), (9).
A comment requested that the anti-abuse rule for transactions
involving intermediaries acting as a conduit be modified so that it
would not apply to transactions where taxpayers restructure their
operations in a way that reduces their base erosion payments because
they have moved operations to the United States. The comment asserted
that proposed Sec. 1.59A-9(b)(1) should not apply where taxpayers
restructure their operations for business reasons even if, under the
resulting structure, payments are made to a foreign related party
through an intermediary. As an example, the comment suggested that
taxpayers might restructure their business so that a domestic related
party performs functions previously performed by a foreign related
party. However, if the foreign related party continues to perform some
functions that benefit the taxpayer, and payments for those functions
are made through the
[[Page 67003]]
domestic related party, the comment suggested that proposed Sec.
1.59A-9(b)(1) could apply to the transaction. The determination of
whether proposed Sec. 1.59A-9(b)(1) will apply to a transaction is
dependent, in part, on whether the transaction has a principal purpose
of avoiding a base erosion payment or reducing the amount of a base
erosion payment. The requested exception could lead to inappropriate
results where the change in the taxpayer's operations is insignificant
compared to the impact of reducing the taxpayer's base erosion
payments. Accordingly, the final regulations do not include the
requested exception.
Another comment requested clarification on when the anti-abuse rule
in proposed Sec. 1.59A-9(b)(1) could apply to a ``corresponding
payment'' to an intermediary that would have been a base erosion
payment if made to a foreign related party. The final regulations do
not modify this rule because the rule is already clear that it applies
to a corresponding payment that is part of a transaction, plan, or
arrangement that has a principal purpose of avoiding a base erosion
payment, and the final regulations include examples of transactions
with such a purpose. Another similar comment requested clarification on
when the anti-abuse rule in proposed Sec. 1.59A-9(b)(1) could apply to
an ``indirect'' corresponding payment. The final regulations do not
modify this rule because it is already clear that transactions
involving conduits and intermediaries can include transactions
involving multiple intermediaries, for example, multiple intermediary
lenders in a fact pattern similar to that in proposed Sec. 1.59A-
9(c)(4) (Example 4), and thus expanding that example to involve another
intermediary would be redundant.
Other comments asked for a clarification that the anti-abuse rule
for transactions designed to inflate the denominator of the base
erosion percentage applies only to non-economic deductions such as
those described in the example in proposed Sec. 1.59A-9(c)(5) (Example
5). One comment recommended that the rule be limited to deductions and
losses incurred for ``the'' principal purpose of increasing the
denominator. The comment expressed a concern that the rule could be
interpreted as applying to deductions and losses on transactions
undertaken in the ordinary course of a taxpayer's business. The final
regulations do not change the standard for determining whether
transactions that increase the denominator of the base erosion
percentage are abusive. Narrowing the rule to apply only to
transactions where the single principal purpose is to increase the
denominator of the base erosion percentage would make it difficult to
administer in all but the most egregious cases. Further, it is a common
formulation for anti-abuse rules to apply when ``a principal purpose''
or ``one of the principal purposes'' of a transaction is to avoid a
particular provision. See, for example, section 954(h)(7)(A), (C), and
(D); section 965(c)(3)(F); see also 60 FR 46500, 46501 (rejecting
comments requesting that an anti-avoidance rule of Sec. 1.954-1(b)(4)
apply only if a purpose of first importance, rather than a principal
purpose, was to avoid the de minimis test of Sec. 1.954-1(b)(1)(i)
because the suggested standard would be ``significantly more
subjective'' than the test adopted and therefore inadministrable).
However, the final regulations address the requests for clarity
regarding the treatment of transactions entered into in the ordinary
course of a taxpayer's business by adding a new example of the
application of Sec. 1.59A-9(b)(2). See Sec. 1.59A-9(c)(7).
One comment requested that the anti-abuse rule with respect to the
disaffiliation of banks and registered securities dealers be removed.
The comment expressed a concern that proposed Sec. 1.59A-9(b)(3) could
effectively prevent taxpayers from disaffiliating a bank or registered
securities dealer, notwithstanding the fact that disaffiliation could
have other non-tax effects. The comment suggested that if a
disaffiliation made sense from a business perspective and is
permissible under applicable banking and securities rules, the Treasury
Department and the IRS should not treat disaffiliation as abusive. The
Treasury Department and the IRS have determined that disaffiliation of
a bank or registered securities dealer could be abusive in certain
circumstances, such as the interposition of entities other than
``includible corporations'' (as defined in section 1504(b)) with a
principal purpose of avoiding the rules applicable to banks and
registered securities dealers. Moreover, in developing guidance under
various Code provisions, the Treasury Department and IRS often consider
that disaffiliation could potentially avoid the purposes of a
provision. See, for example, Sec. 1.904(i)-1, which similarly limits
the use of deconsolidation to avoid foreign tax credit limitations. See
59 FR 25584. Therefore, the final regulations retain Sec. 1.59A-
9(b)(3). However, the final regulations address the concern raised by
the comment by providing examples to clarify the types of transactions
that the Treasury Department and the IRS consider to be abusive. See
Sec. 1.59A-9(c)(8) and (9).
Finally, a comment recommended excluding from the anti-abuse rule
transactions entered into, or pursuant to a binding commitment that was
in effect, before the date of public announcement of certain provisions
in section 59A. The final regulations do not adopt this recommendation.
The anti-abuse rule in Sec. 1.59A-9 is based on the specific grant of
authority in section 59A(i), and the Treasury Department and the IRS
decline to adopt a grandfathering rule when no such rule was adopted by
statute.
X. Rules Relating to Insurance Companies
Section 59A(d)(3) provides that the term ``base erosion payment''
includes any premium or other consideration paid or accrued by a
taxpayer to a foreign related party for any reinsurance payments that
are taken into account under sections 803(a)(1)(B) or 832(b)(4)(A). The
preamble to the proposed regulations requests comments regarding
several issues relating to insurance companies. Specifically, the
preamble to the proposed regulations requests comments regarding
certain reinsurance agreements and other commercial agreements with
reciprocal payments that are settled on a net basis. REG-104259-18, 83
FR 65968 (December 21, 2018).
Comments were also requested with respect to whether claims
payments for losses incurred and other deductible payments made by a
domestic reinsurance company to a foreign related insurance company are
base erosion payments within the scope of section 59A(d)(1). REG-
104259-18, 83 FR 65968 (December 21, 2018). The proposed regulations,
however, did not provide any exceptions specific to the insurance
industry.
Comments received generally addressed whether (1) claims payments
for losses incurred (claims payments) under reinsurance contracts
should be treated as base erosion payments, and (2) certain payments
made pursuant to reinsurance contracts should be netted. For a
discussion of comments relating to life/non-life consolidated returns,
see Part XI of this Summary of Comments and Explanation of Revisions.
A. Reinsurance Claims Payments to a Related Foreign Insurance Company
The proposed regulations do not provide specific rules for payments
by
[[Page 67004]]
a domestic reinsurance company to a related foreign insurance company.
The preamble to the proposed regulations notes the treatment of claims
payments for purposes of section 59A may be different for life
insurance companies and non-life insurance companies. REG-104259-18, 83
FR 65968 (December 21, 2018). For a life insurance company, payments
for claims or losses incurred are deductible pursuant to sections
805(a)(1); therefore, these payments are potentially within the scope
of section 59A(d)(1). With respect to non-life insurance companies,
however, the preamble to the proposed regulations notes that certain
claims payments for losses incurred may be treated as reductions in
gross income under section 832(b)(3), rather than deductions under
section 832(c). To the extent not covered by section 59A(d)(3), these
payments treated as reductions in gross income may not be within scope
of section 59A.
Generally, comments requested that the final regulations provide an
exception to the term ``base erosion payment'' for claims payments made
by a domestic reinsurance company to a related foreign insurance
company. Some comments recommended that the exception should apply only
to claims payments with respect to reinsurance that ultimately relates
to the risk of unrelated third parties. Comments also stated that there
was no apparent policy reason for treating life and non-life insurance
claims payments differently for purposes of section 59A, although one
comment noted that this distinction between life and non-life insurance
claims payments results from the different approaches taken in drafting
section 801(b) and section 832(b)(3), and that the Code sometimes
provides disparate results.
Comments explained that an exception for claims payments by a
domestic reinsurance company to a related foreign insurance company
would provide symmetrical treatment for life insurance companies and
non-life insurance companies. In addition, comments noted that
reinsurance transactions with respect to which outbound claims payments
are made do not base erode because they result from insurance business
that is moved into the United States; therefore, it is appropriate to
provide an exception similar to the TLAC exception and the exception
for foreign currency losses. As noted, several comments requested an
exception for reinsurance claims payments only to the extent that the
claims payments are with respect to policies ultimately insuring third-
party risks. Comments stated that because the reinsurance claims
payments are payable only when an unrelated third party makes a claim
under an insurance policy that the domestic insurance company has
reinsured (and the nature of those claims payments are non-routine and
often large and unpredictable), the timing and amount of the claims
payment are not controlled by the related parties. Finally, comments
noted that foreign regulatory requirements generally require that a
local entity provide insurance to its residents; as a result of these
regulatory requirements, domestic companies that want to provide
insurance in many jurisdictions must do so by reinsuring a subsidiary
established in the local jurisdiction.
Comments also addressed how an exception for claims payments should
impact the base erosion percentage calculation. Generally, comments
recommended that claims payments be excluded from the numerator, but
included in the denominator. If claims payments were eliminated from
the denominator, comments noted that a significant amount of business
expenses would be removed from the base erosion percentage calculation.
Several comments acknowledged that the final regulations may adopt an
exception that applies to both the numerator and the denominator; in
that case, comments recommended that claims payments should be
eliminated from the denominator of the base erosion percentage only to
the extent that the payments are made to a foreign related party.
Comments also indicated that the ambiguity regarding whether a claims
payment is a deduction or a reduction in gross income for non-life
insurance companies could result in taxpayers taking inconsistent
positions and may lead to controversy regarding the calculation of the
denominator for the base erosion percentage.
Finally, several comments noted that certain self-help remedies
with respect to claims payments are not available for insurance
companies. First, because insurance companies are per se corporations
under Sec. 301.7701-2(b)(4), an election under Sec. 301.7701-3 to
treat a related foreign insurance company as a disregarded entity for
U.S. tax purposes is unavailable. In addition, comments stated that
regulators in some jurisdictions would prohibit a local insurance
company from making an election to be treated as a U.S. taxpayer
pursuant to section 953(d) if the election would result in U.S.
withholding tax with respect to payments to policyholders.
Section 1.59A-3(b)(3)(ix) adopts the recommendation from these
comments and provides a specific exception for deductible amounts for
losses incurred (as defined in section 832(b)(5)) and claims and
benefits under section 805(a) (``claims payments'') paid pursuant to
reinsurance contracts that would otherwise be within the definition of
section 59A(d)(1), to the extent that the amounts paid or accrued to
the related foreign insurance company are properly allocable to amounts
required to be paid by such company (or indirectly through another
regulated foreign insurance company), pursuant to an insurance,
annuity, or reinsurance contract, to a person other than a related
party. The final regulations also clarify that all claims payments are
included in the denominator of the base erosion percentage, except to
the extent excepted from the definition of a base erosion payment under
Sec. 1.59A-3(b)(3)(ix). This treatment in the denominator is
consistent with the treatment in the final regulations of derivatives
and QDPs (discussed in Part VII of this Summary of Comments and
Explanation of Revisions), section 988 foreign exchange losses
(discussed in Part IV.C.4 of this Summary of Comments and Explanation
of Revisions), and deductions for services eligible for the SCM
exception (discussed in Part IV.C.1 of this Summary of Comments and
Explanation of Revisions).
B. Netting With Respect to Insurance Contracts
As discussed in Part IV.A.2 of this Summary of Comments and
Explanation of Revisions, the amount of any base erosion payment is
generally determined on a gross basis, regardless of any contractual or
legal right to make or receive payments on a net basis. The proposed
regulations do not provide an exception to this general rule with
respect to reinsurance agreements.
Several comments recommended that the final regulations permit
netting with respect to reinsurance contracts to better reflect the
economics of the transactions. One comment suggested that the final
regulations permit netting with respect to a single economic
transaction where the parties exchange net value in the form of a
single payment, which would include many reinsurance transactions.
Other comments identified specific types of reinsurance transactions
for which netting should or should not be permitted. For quota share
reinsurance arrangements, comments noted that the proposed regulations
provide that the gross amount of reinsurance premium is a base erosion
payment without considering any inbound payments such
[[Page 67005]]
as reserve adjustments, ceding commissions, and claims payments. Other
comments suggested that the amount of base erosion payments with
respect to modified coinsurance (``modco'') and funds withheld
reinsurance be determined on a net basis (particularly when settlement
is on a net basis) in the final regulations to be consistent with the
norm of paying tax on a net basis.
As background, reinsurance is the transfer from an insurer
(referred to as the ``ceding'' company) to a reinsurer of all or part
of the risk assumed under a policy or a group of policies. A
traditional reinsurance agreement typically requires the ceding company
to pay a reinsurance premium to the reinsurance company and the
reinsurance company to pay a ceding commission to the ceding company.
The reinsurance premium compensates the reinsurer for acquiring the
reinsured obligations. The ceding commission compensates the ceding
company for its expenses incurred in acquiring and managing the
reinsured policies, and may include a profit margin. When the risks are
transferred, the ceding company may reduce its reserves for the
reinsured obligations, and the reinsurance company establishes its own
reserves for the reinsured obligations. In terms of payment flows, it
is common for the ceding commission owed under the reinsurance
agreement to be netted against the reinsurance premium owed, such that
the ceding company remits the reinsurance premium net of the ceding
commission amount. However, both flows are typically separately
identified in the contract and in any case represent reciprocal
economic obligations. When losses are paid under the reinsured
policies, depending on the terms of the reinsurance agreement, the
reinsurer will have corresponding obligations to make payments to the
ceding company (for example, the agreement may require the reinsurer to
reimburse a percentage of total losses, or losses above a certain
dollar threshold).
Under modco and similar funds-withheld reinsurance agreements, the
ceding company retains the assets with respect to the policies
reinsured and generally does not transmit an initial premium payment to
the reinsurer under the agreement. The reinsuring company in a modco
agreement is entitled to premiums and a share of investment earnings on
certain assets, and the ceding company is entitled to expense
allowances (similar to ceding commissions) and reimbursement for losses
paid under the reinsured policies, but the parties make net settlement
payments based on each party's overall entitlement under the agreement
on a periodic basis. Comments noted that in this respect, the
arrangement is similar to making settlement payments under a derivative
contract. In both the modco and traditional reinsurance context,
comments asserted that imposing tax on one leg of a reinsurance
transaction (the premium payment) is not equitable and does not reflect
the economics of the transaction.
A comment recommended that the final regulations exclude ceding
commissions paid by a domestic insurance company to a foreign affiliate
in exchange for the domestic insurance company's reinsurance of foreign
risk from the definition of a base erosion payment. The comment
suggested that this exception would be similar to the exception for
section 988 foreign currency losses and for TLAC securities because an
insurance group should not have a base erosion payment when insurance
regulators dictate the structure of reinsurance agreements. The
comments noted that reinsurance involves substantial payments in both
directions, including premiums, ceding commissions, and claims. The
comment explained that a ceding commission compensates the reinsured
for its policy acquisition costs plus a small profit component and
noted that a substantial amount of the commissions are reimbursements
for third party expenses for many lines of business. For most
reinsurance contracts, a comment noted that ceding commissions and
premiums are separately stated in the reinsurance contract, but not
separately paid. Instead, premiums are paid to the reinsurer net of the
ceding commission.
Several comments expressed strong support for the determination in
the proposed regulations that netting is not permitted with respect to
reinsurance arrangements. Comments indicated that the result from the
proposed regulations is appropriate under current law and necessary to
achieve the legislative goals for the BEAT. Before the enactment of the
BEAT, comments explained that foreign insurance groups had a
significant competitive advantage over U.S.-based insurance companies
because foreign groups were allowed to shift their U.S. earnings into
low-tax jurisdictions using affiliated reinsurance payments. Comments
asserted that section 59A identified reinsurance as a base erosion
payment to close the loophole. Comments also noted that using gross
amounts is consistent with the statutory annual statement that is the
basis for determining taxable income under subchapter L. Comments
explained that the use of gross reinsurance premium, rather than net,
is consistent with the excise tax imposed under section 4371, which
computes the excise tax as a percentage of gross reinsurance payments,
even for a funds-withheld or modco contract (where only net amounts are
transferred between the contracting insurance companies). Finally,
comments noted that when Congress determines that netting is
appropriate with respect to insurance, it specifically permits netting.
See sections 848(d)(1), 72(u)(2)(B), and 834(e); see also sections
803(a) and 832.
Some comments asserted that the statutory language of section
59A(d)(3), which provides that base erosion payments include
consideration paid or accrued ``for any reinsurance payments which are
taken into account under sections 803(a)(1)(B) or 832(b)(4)(A),''
requires treating only the net amounts paid by a domestic company under
a modco-type reinsurance contract as base erosion payments. For
example, in the life insurance context, section 803(a)(1) defines
``premiums'' as:
(A) The gross amount of premiums and other consideration on
insurance and annuity contracts, less
(B) return premiums, and premiums and other consideration arising
out of indemnity reinsurance.
Further, section 59A(c)(2)(A)(iii)(I) closely tracks section
803(a)(1) in its definition of base erosion tax benefit in the life
insurance context as the amount by which ``gross premiums and other
consideration on insurance and annuity contracts'' are reduced by
``premiums and other consideration arising out of indemnity
reinsurance.'' These comments suggested that the phrase ``consideration
arising out of indemnity reinsurance'' suggests a broader view of the
transaction than just reinsurance premiums and is best interpreted as
referring to the net cash settlement payments under a modco-type
reinsurance contract, rather than the gross amount identified in the
contract as reinsurance premium.
Other comments disagreed with this characterization and noted that
section 59A(d)(3) is describing consideration paid or accrued for
reinsurance--that is, payments moving in one direction from the
taxpayer to foreign related party--without describing offsetting or
reciprocal payments. The comments noted that the phrase ``arising out
of indemnity reinsurance'' was merely lifted from preexisting section
803(a)(1)(B), rather than being selected deliberately by Congress to
account for both inflows and outflows under a reinsurance contract.
They noted further that section 803(a)(1)(B) and its non-life
counterpart, section 832(b)(4), use
[[Page 67006]]
parallel structures for measuring the amount of premiums included in
insurance company gross income, starting with total premiums received,
and reducing that total by premiums paid for reinsurance and by return
premiums (that is, premium amounts refunded to the policyholder). The
two provisions do not provide for additional offsets based on
obligations flowing in the other direction, such as ceding commissions
or reinsurance claim payments owed.
Some comments asserted that foreign insurers may decide to reduce
their capacity, discontinue lines of business, or increase pricing as a
result of section 59A. Those comments acknowledged that domestic
reinsurers may pick up the increased capacity, but warned that the
shift to domestic reinsurers would concentrate the insured risk in the
United States rather than spreading it globally, resulting in less risk
diversification (a key element of insurance risk management). Other
comments disagreed with this contention, noting that global reinsurance
capacity has remained strong and that premium increases have been
negligible since the enactment of section 59A.
In contrast, a comment asserted in the context of reinsurance that
it was clear that the law applies on a gross basis, both based on the
plain language of the statute and the intent of Congress, and that
relevant policy considerations weigh heavily in favor of applying the
BEAT on a gross basis. The comment explained that because the
reinsurance transactions at issue are between related parties, they are
not necessarily at arm's length. Further, according to the comment, the
legislative purpose of section 59A was to level the playing field
between U.S. and foreign-owned companies, which can only be advanced if
section 59A is applied on a gross basis.
The final regulations do not adopt the recommendations that
payments made under a reinsurance contract be netted for purposes of
determining the amount of a base erosion payment, unless netting would
otherwise be permitted for U.S. federal income tax purposes. Section
59A's requirements are best interpreted in the context of the existing
body of tax law and regulations. As discussed in Part IV.A.3 of this
Summary of Comments and Explanation of Revisions, amounts of income and
deduction are generally determined on a gross basis under the Code, and
unless a rule permits netting (so that there is no deduction or the
deduction is a reduced amount, as opposed to a deduction offset by an
item of income), no netting is permitted.
Although comments asserted that section 59A(d)(3) (defining a base
erosion payment as including certain reinsurance payments) requires the
netting of ceding commissions and other payments from the related
foreign reinsurance company against reinsurance premiums, the Treasury
Department and IRS are not persuaded by arguments that the language of
section 59A(d)(3) mandates that result. Whether payments under
particular types of reinsurance contracts (for example, modco) may be
netted for purposes of section 59A is determined based on the existing
rules in the Code and regulations regarding netting. The subchapter L
provisions cited in section 59A(d)(3) (section 803(a)(1)(B) for life
insurance companies and section 832(b)(4)(A) for non-life insurance
companies) do not provide for netting of ceding commissions, claims
payments or other expenses against premiums.
With respect to the comment that modco and other reinsurance
contracts that are periodically settled on a net basis are
substantially similar to derivative contracts, the Treasury Department
and IRS note that Congress specified in section 59A(h)(4)(C) that the
term ``derivative'' does not include insurance contracts. This
indicates that Congress did not intend for agreements with derivative-
like characteristics that are also insurance contracts to be treated as
derivatives for purposes of section 59A.
With respect to comments that ceding commissions should be broken
down into components and not treated as base erosion payments to the
extent that they reimburse amounts paid to third parties, this scenario
is not materially different from those described in comments received
from taxpayers in other industries and discussed in Part IV.A.1 of this
Summary of Comments and Explanation of Revisions. These other comments
described various scenarios in which a domestic corporation makes a
deductible payment to a foreign related party, and that foreign related
party in turn makes deductible payments to unrelated third parties.
Therefore, the final regulations do not adopt a narrower regulatory
exception for payments to foreign related insurance companies that
arise in connection with a regulatory requirement.
XI. Comments and Changes to Sec. 1.1502-59A
A. In General
Proposed Sec. 1.1502-59A provides rules regarding the application
of section 59A and the regulations thereunder to consolidated groups.
Under these rules, all members of a consolidated group are treated as a
single taxpayer for purposes of determining whether the group is an
applicable taxpayer and the amount of tax due under section 59A. For
example, items resulting from intercompany transactions (as defined in
Sec. 1.1502-13(b)(1)(i)) are disregarded for purposes of making the
required computations.
Some comments requested clarification on what it means for
intercompany transactions to be ``disregarded'' in making the required
computations under section 59A. Generally, intercompany transactions
should not change the consolidated taxable income or consolidated tax
liability of a consolidated group. For example, where one member (S)
sells depreciable property to another member (B) at a gain, S's gain on
the sale is deferred. Every year, as B depreciates the property, S
recognizes a portion of its deferred gain. As a result, the
depreciation expense deducted by B that exceeds the depreciation
expense the group would have deducted if S and B were divisions of a
single entity (``additional depreciation'') is offset by the amount of
gain S recognizes each year, and the intercompany sale does not change
the consolidated taxable income.
However, the base erosion percentage is generally computed based
solely on deductions; income items are not relevant. Therefore, under
the foregoing example, B's depreciation deduction would include the
additional depreciation amount, but S's offsetting gain inclusion would
be excluded from the base erosion percentage computation.
To make clear that intercompany transactions may not impact the
BEAT consequences of a consolidated group, these final regulations
clarify in Sec. 1.1502-59A(b)(1) that items resulting from
intercompany transactions are not taken into account in computing the
group's base erosion percentage and BEMTA. Consequently, in the
foregoing example, B's additional depreciation is not taken into
account in computing the group's base erosion percentage.
In addition, some comments raised concerns that the proposed
section 59A regulations and proposed Sec. 1.1502-59A may be
incompatible with the rules and framework of Sec. 1.1502-47 for life-
nonlife consolidated groups. The
[[Page 67007]]
Treasury Department and the IRS are analyzing these concerns and expect
to address the issues in future proposed regulations, and thus reserve
on this matter in the final regulations.
B. New Rules Under Sec. 1.1502-59A(c) When a Member Deconsolidates
From a Consolidated Group With a Section 163(j) Carryforward
Proposed section 1.1502-59A(c)(3) provides rules to determine
whether a consolidated group's business interest deduction permitted
under section 163(j) is a base erosion tax benefit. Due to the
fungibility of money, these rules generally treat the consolidated
group as a single entity and aggregate all members' current-year
business interest expense paid to nonmembers. The current-year business
interest expense deducted by members is then classified as an amount
paid or accrued to a domestic related party, foreign related party, or
unrelated party based on specified allocation ratios, which are based
on the entire group's business interest expense paid. If members cannot
fully deduct their current-year business interest expense, then the
members' section 163(j) carryforwards are allocated a status as a
domestic related carryforward, foreign related carryforward, or
unrelated carryforward based on specified allocation ratios. Such
status is taken into account for BEAT purposes in future years when the
member deducts its section 163(j) disallowed business interest expense
carryforward, whether the member remains in the group or
deconsolidates.
A comment requested a special rule under Sec. 1.1502-59A(c)(3) for
certain situations in which a member (T) deconsolidates from a
consolidated group (the original group) that was not an applicable
taxpayer under section 59A and joins an unrelated consolidated group.
Assume that, during the time T was a member of the original group, T
incurred business interest expense that could not be fully deducted and
has a section 163(j) disallowed business interest expense carryforward.
T then deconsolidates from the original group and joins the new group,
which is an applicable taxpayer under section 59A. The comment
recommended allowing T to use the special allocation ratios under Sec.
1.1502-59A(c)(3) of the new group for the taxable year of the
acquisition (rather than the allocation ratios of the original group).
The comment posited that the original group would not have determined
or maintained information pertaining to the allocation ratios because
the original group was not an applicable taxpayer.
The final regulations do not adopt this special rule. Whether a
business interest expense deducted by members of a consolidated group
is a base erosion tax benefit is determined on a single-entity basis,
without regard to which member actually incurred the payment to the
domestic related, foreign related, or unrelated party. Therefore, in
the foregoing example, whether T's deduction of its section 163(j)
disallowed business interest expense carryforward is a base erosion tax
benefit must be determined by reference to the original group, not the
new group.
Furthermore, to determine whether a consolidated group is an
applicable taxpayer, the group generally must determine its base
erosion percentage for the year. In order to do so, the group must
apply the classification rule under Sec. 1.1502-59A(c)(3) to its
aggregate current-year business interest expense that was deducted.
Therefore, the original group should have the information relevant to
the classification rule under Sec. 1.1502-59A(c)(3), regardless of
whether it was an applicable taxpayer. Consequently, the final
regulations do not adopt the rule recommended by the comment.
However, the final regulations provide two rules for situations in
which a member deconsolidates from the original consolidated group with
a section 163(j) carryforward. The first rule is an exception that
applies if the original group was not an applicable taxpayer because it
did not meet the gross receipts test in the year the business interest
expense at issue was incurred. Under these circumstances, application
of the classification rule under Sec. 1.1502-59A(c)(3) would have been
unnecessary within the original consolidated group with regard to the
year in which the interest was paid or accrued. This special rule
permits the deconsolidating member (and any acquiring consolidated
group) to apply the classification rule on a separate-entity basis to
determine the status of the deconsolidating member's section 163(j)
disallowed business interest expense carryforward as a payment or
accrual to a domestic related, foreign related, or unrelated party. The
second rule applies if the deconsolidating member (or its acquiring
consolidated group) fails to substantiate the status of its section
163(j) disallowed business interest expense carryforward from the
original group. In that case, the section 163(j) disallowed business
interest expense carryforward is treated as a payment or accrual to a
foreign related party.
Applicability Dates
Pursuant to section 7805(b)(1)(B), these final regulations (other
than the reporting requirements for QDPs in Sec. 1.6038A-2(b)(7),
Sec. 1.1502-2, and Sec. 1.1502-59A) apply to taxable years ending on
or after December 17, 2018. However, taxpayers may apply these final
regulations in their entirety for taxable years ending before December
17, 2018. Taxpayers may also apply provisions matching Sec. Sec.
1.59A-1 through 1.59A-9 from the Internal Revenue Bulletin (IRB) 2019-
02 (https://www.irs.gov/pub/irs-irbs/irb19-02.pdf) in their entirety
for all taxable years ending on or before December 6, 2019. Taxpayers
choosing to apply the proposed regulations must apply them consistently
and cannot selectively choose which particular provisions to apply.
Section 1.6038A-2(b)(7)(ix) applies to taxable years beginning
Monday, June 7, 2021. No penalty under sections 6038A(d) or 6038C(c)
will apply to a failure solely under Sec. 1.6038A-2(a)(3), (b)(6), or
(b)(7) that is corrected by March 6, 2020.
Pursuant to sections 1503(a) and 7805(b)(1)(A), Sec. 1.1502-2 and
Sec. 1.1502-59A apply to taxable years for which the original
consolidated Federal income tax return is due (without extensions)
after December 6, 2019. However, taxpayers may apply Sec. 1.1502-2 and
Sec. 1.1502-59A in their entirety for taxable years for which such a
return is due (without extensions) before December 6, 2019.
Statement of Availability of IRS Documents
IRS revenue procedures, revenue rulings, notices, and other
guidance cited in this preamble are published in the Internal Revenue
Bulletin and are available from the Superintendent of Documents, U.S.
Government Publishing Office, Washington, DC 20402, or by visiting the
IRS website at http://www.irs.gov.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 13563 and 12866 direct agencies to assess costs
and benefits of available regulatory alternatives and, if regulation is
necessary, to select regulatory approaches that maximize net benefits
(including potential economic, environmental, public health and safety
effects, distributive impacts, and equity). Executive Order 13563
emphasizes the importance of quantifying both costs and benefits, of
[[Page 67008]]
reducing costs, of harmonizing rules, and of promoting flexibility. For
purposes of Executive Order 13771, this rule is regulatory.
These final regulations have been designated as subject to review
under Executive Order 12866 pursuant to the Memorandum of Agreement
(April 11, 2018) between the Treasury Department and the Office of
Management and Budget (OMB) regarding review of tax regulations. The
Office of Information and Regulatory Affairs has designated these
regulations as economically significant under section 1(c) of the MOA.
Accordingly, the OMB has reviewed these regulations.
A. Background
The Tax Cuts and Jobs Act of 2017 (the ``Act'') added new section
59A, which applies to large corporations that have the ability to
reduce U.S. tax liabilities by making deductible payments to foreign
related parties. The Base Erosion and Anti-Abuse Tax (``BEAT'') is
generally levied on certain large corporations that have deductions
paid or accrued to foreign related parties that are greater than three
percent of their total deductions (two percent in the case of certain
banks or registered securities dealers), a determination referred to as
the base erosion percentage test. Large corporations are those with
gross receipts of $500 million or more, as calculated under the rules
of section 59A, a determination referred to as the gross receipts test.
By taxing these corporations' base erosion tax benefits, the BEAT
``aims to level the playing field between U.S. and foreign-owned
multinational corporations in an administrable way.'' Senate Committee
on Finance, Explanation of the Bill, S. Prt. 115-20, at 391 (November
22, 2017). The BEAT operates as a minimum tax, so a taxpayer is only
subject to additional tax under the BEAT if the BEAT tax rate
multiplied by the taxpayer's modified taxable income exceeds the
taxpayer's regular tax liability adjusted for certain credits.
B. Need for the Final Regulations
Section 59A is largely self-executing, which means that it is
binding on taxpayers and the IRS without any regulatory action.
Although it is self-executing, the Treasury Department and the IRS
recognize that section 59A provides interpretive latitude for taxpayers
and the IRS which could create uncertainty and prompt a variety of
taxpayer responses without further guidance. The final regulations are
needed to address questions regarding the application of section 59A
and to reduce compliance burden and economic inefficiency that would be
caused by uncertainty about how to calculate tax liability.
C. Overview of the Final Regulations
These final regulations provide guidance under section 59A
regarding the determination of the tax with respect to base erosion
payments for certain taxpayers with substantial gross receipts. They
provide guidance for applicable taxpayers to determine the amount of
BEAT liability and how to compute the components of the tax
calculation.
Regulations under section 59A (Sec. Sec. 1.59A-1 through 1.59A-10)
provide details for taxpayers regarding whether a taxpayer is an
applicable taxpayer and the computation of certain components of the
base erosion minimum tax amount, including the amount of base erosion
payments, the amount of base erosion payments that are treated as base
erosion tax benefits, and modified taxable income. The regulations also
provide specific guidance for banks, registered securities dealers, and
insurance companies, and provide guidance in applying section 59A to
amounts paid by and to partnerships. These regulations also establish
anti-abuse rules to prevent taxpayers from taking measures to
inappropriately circumvent section 59A.
Regulations under sections 383, 1502 and 6038A (Sec. Sec. 1.383-1,
1.1502-2, 1.1502-59A, 1.6038A-1, 1.6038A-2, and 1.6038-4) provide rules
for the application of section 59A with respect to limitations on
certain capital losses and excess credits, consolidated groups and
their members, and reporting requirements, which include submitting, in
certain cases, new Form 8991, Tax on Base Erosion Payments of Taxpayers
With Substantial Gross Receipts.
D. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of these final regulations compared to a no-action baseline that
reflects anticipated Federal income tax-related behavior in the absence
of these final regulations.
2. Summary of Economic Effects
These final regulations provide certainty and clarity to taxpayers
regarding the meaning of terms and calculations they are required to
apply under the BEAT provisions of the Act. In the absence of the
enhanced specificity provided by these regulations, similarly situated
taxpayers might interpret the statutory rules of section 59A
differently, potentially resulting in inefficient patterns of economic
activity. For example, two otherwise similar taxpayers might structure
an income-generating activity differently based solely on different
assumptions about whether that activity will involve payments that are
subject to the BEAT. If this tax-driven difference in business
structures confers a competitive advantage on the less profitable
enterprise, U.S. economic performance may suffer. This final regulatory
guidance thus provides value by helping to ensure that economic agents
face similar tax incentives, a tenet of economic efficiency.
The Treasury Department and the IRS project that under these final
regulations, 3,500-4,500 taxpayers may be applicable taxpayers under
the BEAT because those taxpayers (1) are U.S. shareholders of a foreign
corporation, 25 percent foreign-owned corporations, or foreign
corporations engaged in a trade or business within the United States
and (2) have gross receipts of $500 million or more without taking into
account the gross receipts of members of its aggregate group. As many
as 100,000-110,000 additional taxpayers may be applicable taxpayers as
a result of being members of an aggregate group.\5\
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\5\ These estimates are based on current tax filings for taxable
year 2017 and do not yet include the BEAT. At this time, the
Treasury Department and the IRS do not have readily available data
to determine whether a taxpayer that is a member of an aggregate
group will meet all tests to be an applicable taxpayer for purposes
of the BEAT.
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The Treasury Department and the IRS recognize that in response to
these final regulations, these businesses may alter the way they
transact with related versus unrelated parties. They may make changes
to financial arrangements, supply chain arrangements, or the locations
of business activity, each in ways that increase or reduce the volume
of payments made to a foreign affiliate that qualify as base erosion
payments, relative to the decisions they would make under alternative
regulatory approaches, including the no-action baseline. These
differences in business activities may have economic effects beyond
their effects on taxpayers' tax liability.
The Treasury Department and the IRS have not attempted to quantify
the economic effects of any changes in business activity stemming from
these final regulations. The Treasury Department and the IRS do not
have readily available data or models that predict with reasonable
precision the decisions that businesses would make under the final
regulations versus
[[Page 67009]]
alternative regulatory approaches. Nor do they have readily available
data or models that would measure with reasonable precision the loss or
gain in economic surplus resulting from these business decisions
relative to the business decisions that would be made under an
alternative regulatory approach. Such estimates would be necessary to
quantify the economic effects of the final regulations versus
alternative approaches.
Within these limitations, part I.D.3 of these Special Analyses (and
the Summary of Comments and Explanation of Revisions) explains the
rationale behind the final regulations and provides a qualitative
assessment of the economic effects of the final regulations relative to
the alternative regulatory approaches that were considered.
The Treasury Department and the IRS welcome comments on these
conclusions and on the economic effects of the provisions described in
the following sections.
3. Economic Effects of Provisions Substantially Revised From the
Proposed Regulations
a. Securities Lending Transactions
Section 59A(h) includes an exception to base erosion payment status
for certain payments by a corporation to a foreign related party
pursuant to certain derivative contracts (qualified derivative
payments, or QDPs). The statute further provides that the QDP exception
does not apply to a payment pursuant to a derivative contract that
would be treated as a base erosion payment if the payment was not made
pursuant to a derivative contract. The final regulations specify how
the QDP exception applies to securities lending transactions, a
particular form of financial transaction. In this regard, the final
regulations generally provide parity in the treatment of securities
lending transactions and sale-repurchase transactions, a similar,
alternative form of financial transaction. This part I.D.3.a discusses
the treatment of securities lending transactions and sale-repurchase
transactions under the final regulations. For a further description of
securities lending transactions and sale-repurchase transactions, see
Part VII.B of the Summary of Comments and Explanation of Revisions.
In general, a sale-repurchase transaction is an agreement under
which a person transfers a security in exchange for cash and
simultaneously agrees to receive substantially identical securities
from the transferee in the future in exchange for cash. Certain sale-
repurchase transactions are treated as secured debt for federal tax
purposes; that is, the nominal seller of the securities in the sale-
repurchase transaction is treated as transferring securities as
collateral for a loan from the nominal buyer to the nominal seller. The
fee paid by the nominal seller to the nominal buyer pursuant to this
type of sale-repurchase contract is one example of a payment that does
not qualify for the QDP exception.
In this type of sale-repurchase transaction, the nominal seller
remains the beneficial owner of the securities for federal income tax
purposes and is treated as a cash borrower from the nominal buyer.
Because the nominal seller remains the beneficial owner of the
securities for federal income tax purposes, when the nominal buyer
receives any payments with respect to the securities and passes those
payments through to the nominal seller (known as substitute payments),
such as interest or dividends, the nominal seller is treated as
receiving that payment directly from the issuer of the security for
federal income tax purposes. Thus, the substitute payment is not
considered a payment between the nominal seller and the nominal buyer
for federal tax purposes. Consequently, even if the nominal buyer is a
U.S. person and the nominal seller is a foreign related party, the
substitute payments on the sale-repurchase agreement that is treated as
a loan for federal tax purposes generally are not base erosion payments
for the BEAT.
Certain securities lending transactions are economically similar to
sale-repurchase transactions but are treated differently for federal
income tax purposes. In some securities lending transactions, a
securities lender also transfers securities to a securities borrower in
exchange for an obligation that the securities borrower make certain
payments to the securities lender and also return identical (though not
necessarily the same) securities to the securities lender. In
connection with the transfer of securities in this type of transaction,
the securities borrower may also provide cash or other form of
collateral to the securities lender, often with the same or greater
value as the lent security. Economically, the securities lender in
these transactions can be viewed as both a lender of securities to the
counterparty, and a borrower of cash from the counterparty. In these
respects, the securities lending transaction is economically similar to
a sale-repurchase transaction.
However, in these securities lending transactions, the securities
lender is no longer treated as the beneficial owner of the securities
for federal income tax purposes. As a result, when the securities
borrower makes substitute payments (with respect to the securities) in
the securities lending transaction, those substitute payments may be
base erosion payments (without regard for the QDP exception) if the
securities lender is a foreign related party because the substitute
payments are treated as payments from the securities borrower to the
securities lender for federal income tax purposes.
The proposed regulations state that sale-repurchase transactions
are not eligible for the QDP exception. The proposed regulations
further provide that securities lending transactions are not eligible
for the QDP exception because the securities lending transactions are
economically similar to sale-repurchase transactions. However, as
discussed in this part I.D.3.a, substitute payments on a sale-
repurchase transaction are not a base erosion payment because the
nominal seller of the securities is treated as remaining the beneficial
owner of the securities for federal income tax purposes. Comments
observed that the proposed regulations thus failed to take into account
the disparate tax treatment of substitute payments for sale-repurchase
transactions and securities lending transactions for purposes of the
BEAT.
To take into account the disparate treatment of the substitute
payments in securities lending transactions, the final regulations
remove the per se exclusion of securities lending transactions from the
QDP exception. Instead, the final regulations more narrowly exclude the
borrowing of cash pursuant to a securities lending transaction (``cash
leg'') from the QDP exception. This change provides symmetry with the
treatment of a sale-repurchase transaction that is treated as a secured
loan for federal income tax purposes. Under the final regulations, both
a sale-repurchase transaction and the cash leg of a securities lending
transaction are excluded from the QDP exception to the extent that they
are treated as financings, and thus may be base erosion payments.
The final regulations no longer exclude payments attributable to
the borrowing of securities pursuant to a securities lending
transaction from qualifying for the QDP exception; as a result,
substitute payments on the security may qualify for the QDP exception.
This change in the final regulations provides general symmetry in the
treatment of substitute payments made pursuant to sale-repurchase
[[Page 67010]]
transactions and securities lending transactions for purposes of the
BEAT.
The final regulations also provide an anti-abuse rule to address a
potentially abusive transaction characterized by an uncollateralized
borrowing of securities that can be liquidated for cash in a multiple-
step transaction that is economically similar to an uncollateralized
cash loan.
Specifically, the Treasury Department and the IRS adopted an anti-
abuse rule that takes into account two factors: (a) Whether the
securities lending transaction or substantially similar transaction
provides the taxpayer with the economic equivalent of a substantially
unsecured cash borrowing and (b) whether the transaction is part of an
arrangement that has been entered into with a principal purpose of
avoiding the treatment of any payment with respect to the transaction
as a base erosion payment.
The Treasury Department and the IRS considered an alternative anti-
abuse rule that would have applied solely on the basis of the
securities loan being undercollateralized. The Treasury Department and
the IRS did not adopt this alternative in the final regulations because
the Treasury Department and the IRS are cognizant that an objective
mechanical rule based solely on the level of collateralization may be
difficult for both taxpayers and the IRS to apply, in particular due to
the high volume of transactions issued under varying conditions.
Accordingly, the final regulations further provide that for the anti-
abuse rule to apply, the transactions must also be part of an
arrangement that has been entered into with a principal purpose of
avoiding the treatment of any payment with respect to the transaction
as a base erosion payment. See Sec. Sec. 1.59A-6(d)(2)(iii)(C); 1.59A-
6(e)(2) (Example 2).
The Treasury Department and the IRS recognize that in response to
these final regulations, businesses may increase the volume of certain
securities lending transactions relative to the volume that would occur
under alternative anti-abuse rules. The Treasury Department and the IRS
project, however, that taxpayer response to these rules, and the
relative economic effects of adoption of the final rule, will be minor
given the wide range of financial transactions that applicable
taxpayers currently engage in, the various roles that securities
lending transactions play, and the relatively small difference in
regulatory treatment between the final regulations and alternative
anti-abuse rules.
The Treasury Department and the IRS have not attempted to provide a
quantitative prediction of the change in the volume of securities
lending transactions nor to quantify the economic effects of this
potential shift that may result from the final regulations, relative to
alternative regulatory approaches. The Treasury Department and the IRS
do not have readily available data or models that predict with
reasonable precision the types of intercompany arrangements that
businesses would adopt under the final regulations versus alternative
regulatory approaches. Nor do they have readily available data or
models that would measure with reasonable precision the difference in
returns or risk that would occur as a result of this shift in the
volume of securities lending transactions relative to the alternative
regulatory approach. Such estimates would be necessary to quantify the
economic effects of these final regulations over the treatment of
securities lending transactions versus alternative regulatory
approaches.
Profile of affected taxpayers. The taxpayers affected by these
provisions of the final regulations are domestic banks and broker-
dealers that engage in securities lending transactions with a foreign
related party where the domestic bank or broker-dealer is the
securities borrower that makes substitute payments to the foreign
related party. The taxpayers affected are also foreign banks and
broker-dealers that engage in these securities lending transactions
with a foreign related party as part of their conduct of a U.S. trade
or business.
To provide an estimate of taxpayers affected by the change to the
QDP rule, the Treasury Department and the IRS used current tax filings
for taxable year 2017 and examined the set of filers who marked-to-
market securities and were (1) U.S. shareholders of a foreign
corporation as indicated by the filing of Form 5471 or (2) otherwise
potentially applicable taxpayers as indicated by the filing of Form
5472. This marked-to-market proxy is reasonable because the QDP
exception applies only if a taxpayer recognizes gain or loss as if the
derivative were sold for fair market value on the last day of the
taxable year and treats that gain or loss as ordinary. Based on these
tax data, the number of taxpayers estimated to be affected by these
provisions of the final regulations is 900, based on counts of the
forms shown in the accompanying table.
Taxpayers Affected by Sec. 1.59A
[Estimate based on current tax filings for taxable year 2017]
------------------------------------------------------------------------
Estimated
impacted
filer counts
------------------------------------------------------------------------
Form 1120 with mark-to-market on Form M3 and Form 5471 750
and/or 5472............................................
Form 1120F who completed line u of the Additional 150
Information and Form 5471 and/or 5472..................
------------------------------------------------------------------------
b. Section 988 Losses in the Denominator of the Base Erosion Percentage
Under section 59A, a taxpayer is subject to the BEAT only if the
taxpayer meets the statutory tests to be an applicable taxpayer,
including the base erosion percentage test. The base erosion percentage
test is satisfied with respect to a taxpayer if the taxpayer (or, if
the taxpayer is a member of an aggregate group, that aggregate group)
has a base erosion percentage of three percent or more. A lower
threshold of two percent generally applies if the taxpayer, or a member
of the taxpayer's aggregate group, is a member of an affiliated group
that includes a domestic bank or registered securities dealer. The
final regulations specify how losses from certain currency exchange
transactions should be included in the base erosion percentage test.
Proposed Sec. 1.59A-3(b)(3)(iv) provides that exchange losses from
section 988 transactions described in Sec. 1.988-1(a)(1) are excluded
from the definition of base erosion payments. Section 988 transactions
are generally transactions in which the amount that the taxpayer is
entitled to receive (or required to pay) is denominated in terms of a
nonfunctional currency or is determined by reference to one or more
nonfunctional currencies. In the
[[Page 67011]]
proposed regulations, the Treasury Department and the IRS determined
that this section 988 exception from the definition of a base erosion
payment is appropriate because those losses do not present the same
base erosion concerns as other types of losses that arise in connection
with payments to a foreign related party. Because exchange losses from
section 988 transactions are excluded from the definition of base
erosion payments in the proposed regulations, those losses are not
included in the numerator of the base erosion percentage under the
proposed regulations. The final regulations retain the exclusion of
section 988 losses from the definition of base erosion payments and
from the numerator of the base erosion percentage.
Proposed Sec. 1.59A-2(e)(3)(ii)(D) also provides that exchange
losses from section 988 transactions (including with respect to
transactions with persons other than foreign related parties) are not
included in the denominator when calculating the base erosion
percentage for purposes of the base erosion percentage test. In
response to comments, the final regulations restore the section 988
losses to the denominator when calculating the base erosion percentage,
except to the extent of the amount of section 988 losses from
transactions with foreign related parties that is also excluded from
the numerator of the base erosion percentage.
As an alternative, the Treasury Department and the IRS considered
removing all section 988 losses from the denominator of the base
erosion percentage test. However, the Treasury Department and the IRS
determined that it was appropriate to exclude from the denominator only
the amounts that are excluded from the numerator because that is how
other statutory exceptions from the BEAT are addressed in the base
erosion percentage calculations. Specifically, for the QDP exception
(discussed in Part I.D.3.a of this Special Analysis) and the services
cost method exception (discussed in Part IV.C.1 of the Summary of
Comments and Explanation of Revisions) the amounts in the denominator
of the base erosion percentage are also accounted for in this manner.
That is, the denominator does include the amount of QDP deductions or
services cost method deductions that are also excluded from the
numerator of the base erosion percentage because of those exceptions.
The Treasury Department and the IRS project that under these final
regulations, fewer taxpayers would be expected to satisfy the base
erosion percentage test and therefore fewer would be liable for the
BEAT, relative to the alternative regulatory approach as specified in
the proposed regulations. These final regulations include in the
denominator of the base erosion percentage section 988 losses arising
from foreign currency transactions with unrelated parties. Inclusion of
such losses in the denominator, all else equal, reduces the base
erosion percentage, and may increase the likelihood that businesses
engage in incremental section 988 transactions with unrelated parties
to reduce the base erosion percentage, relative to the proposed
regulations. However, regulations under Sec. 1.59A-9(b)(2) (anti-abuse
rule addressing transactions to increase the amount of deductions taken
into account in the denominator of the base erosion percentage
computation) are expected to limit this behavior.
The Treasury Department and the IRS have not attempted to provide a
quantitative prediction of the change in the volume of section 988
transactions nor to quantify the economic effects of this change
resulting from the final regulations, relative to the alternative
regulatory approach. The Treasury Department and the IRS do not have
readily available data or models that predict with reasonable precision
the volume of section 988 transactions that businesses might engage in
under the final regulations versus the alternative regulatory approach
because of the complex role that currency exchange plays for these
businesses. The Treasury Department and the IRS further do not have
readily available data or models that would measure with reasonable
precision the difference in economic returns or volatility that these
businesses would experience as a result of this shift in section 988
transactions relative to the alternative regulatory approach, again
because of the complex role that currency exchange plays for these
businesses. Such estimates would be necessary to quantify the economic
effects of these final regulations over the treatment of section 988
transactions versus the alternative regulatory approach.
Profile of affected taxpayers. The taxpayers affected by these
provisions of the final regulations generally are those taxpayers that
engage in foreign currency transactions with unrelated parties and have
section 988 losses that will be included in the denominator of the base
erosion percentage under the final regulations.
The Treasury Department and the IRS have not estimated the number
of these taxpayers because the Form 1120 series does not separately
break out gains or losses from section 988 transactions. The sole form
that breaks out section 988 gain and loss is Form 5471, which is filed
by U.S. shareholders of a CFC. Information from Form 5471 is unlikely
to be informative because a CFC is unlikely to be an applicable
taxpayer.
4. Economic Effects of Provisions Not Substantially Revised From the
Proposed Regulations
a. Applicable Taxpayer for Aggregate Groups
A taxpayer is liable for the BEAT only if the taxpayer is an
applicable taxpayer. In general, an applicable taxpayer is a
corporation, other than a RIC, REIT, or an S corporation, that
satisfies the gross receipts test and the base erosion percentage test.
For purposes of these tests, members of a group of corporations related
by certain specified percentages of stock ownership are aggregated.
Section 59A(e)(3) refers to aggregation on the basis of persons treated
as a single taxpayer under section 52(a) (controlled group of
corporations), which includes both domestic and foreign persons. In the
proposed regulations, the Treasury Department and the IRS determined
that to implement the provisions of section 59A, it was necessary to
treat foreign corporations as outside of the controlled group for
purposes of applying the aggregation rules, except to the extent that
the foreign corporation is subject to net income tax under section
882(a) (tax on income of foreign corporations connected with U.S.
business). The final regulations also adopt this position.
Upon aggregation of domestic and foreign controlled groups of
corporations, intra-aggregate group transactions are eliminated for
purposes of the gross receipts test and base erosion percentage test.
If aggregation were defined to include both domestic and all related
foreign persons (i.e., a ``single employer'' under section 52(a)),
regardless of whether the foreign person was subject to tax in the
United States, this would eliminate most base erosion payments, which
are defined by section 59A(d)(1) as ``any amount paid or accrued by the
taxpayer to a foreign person which is a related party of the taxpayer
and with respect to which a deduction is allowed under this chapter.''
Without these base erosion payments, virtually no taxpayer or aggregate
group would satisfy the base erosion percentage test; thus
substantially all taxpayers (or the aggregate group of which the
taxpayer was a member) would be excluded from the requirement to pay a
tax equal to the base erosion minimum tax amount (BEMTA).
[[Page 67012]]
In the proposed regulations, the Treasury Department and the IRS
considered an alternative of not providing guidance on the aggregation
rule in the statute. Absent the proposed regulations, there would be
uncertainty among taxpayers as to whether the tax equal to the BEMTA
would apply to them. Without guidance, different taxpayers would likely
take different positions regarding the determination of their status as
an applicable taxpayer, which would result in inefficient decision-
making and inconsistent application of the statute as taxpayers engage
in corporate restructurings, or adjust investment and spending policies
based on tax planning strategies to manage BEAT liability. No
substantive comments objected to the general approach set forth in the
proposed regulations.
b. Service Cost Method Exception
Section 59A(d)(5) provides an exception from the definition of a
base erosion payment for an amount paid or accrued by a taxpayer for
services if the services are eligible for the services cost method
under section 482 (without regard to certain requirements under the
section 482 regulations) and the amount constitutes the total services
cost with no markup component. The statute is ambiguous as to whether
the SCM exception (1) does not apply to a payment or accrual that
includes a markup component, or (2) does apply to such a payment or
accrual that includes a markup component, but only to the extent of the
total services costs. The proposed regulations follow the latter
approach. See REG-104259-18, 83 FR 65961 (December 21, 2018). The final
regulations retain the same approach. See part IV.C.1 of the Summary of
Comments and Explanation of Revisions.
Alternatives would have been to disallow the SCM exception for the
entire amount of any payment that includes a markup component, or to
not provide any guidance at all regarding the SCM exception. The
Treasury Department and the IRS rejected the former approach. The
section 482 regulations mandate intercompany pricing under an ``arm's
length standard.'' Under specific circumstances, the section 482
regulations provide that intercompany payments for services can be set
by a taxpayer at the cost of providing the service with no profit
markup. However, the section 482 regulations prohibit use of this cost-
only SCM approach for services ``that contribute significantly to
fundamental risks of business success or failure'' (the ``business
judgment rule''). See Sec. 1.482-9(b)(5). At arm's length, such
services generally would be priced to include a profit element to
satisfy the market's demand for, and supply of, services among
recipients and providers. Section 59A(d)(5)(A) explicitly allows an
exception from the BEAT for services that would be eligible for the
SCM, ``determined without regard to [the business judgment rule].'' By
allowing an exception from the BEAT for intercompany service payments
that do not include a profit markup (i.e., under the SCM transfer
pricing method), but also for intercompany service payments that must
apply a different transfer pricing method, and therefore generally
would include a profit markup at arm's length (i.e., those subject to
the business judgment rule), the statute creates ambiguity about the
SCM exception's application with respect to the portion of intercompany
prices paid for services reflecting the cost of providing the services,
when there is also a mark-up component. Thus, the proposed regulations
provide that the SCM exception is available if there is a profit markup
(provided that other requirements are satisfied), but the portion of
any payment exceeding cost is not eligible for the SCM exception.
The Treasury Department and the IRS also rejected the option of not
providing any guidance at all regarding the SCM exception because if
taxpayers relied on statutory language alone, taxpayers would adopt
different approaches due to ambiguity in the statute, leaving it open
to differing statutory interpretations and an inconsistent application
of the statute. Comments supported the SCM exception and recommended
that final regulations adopt the approach from the proposed
regulations.
c. Effectively Connected Income
The final regulations provide an exception from the definition of
base erosion payment for payments to the U.S. branch of a foreign
related person to the extent that the payments are treated as
effectively connected income.
Under section 59A, whether a deductible payment is a base erosion
payment is determined based on whether the recipient is a foreign
person (as defined in section 6038A(c)(3)) and a related party. See
section 59A(f). A foreign person means any person who is not a United
States person. However, the Treasury Department and the IRS determined
in the proposed regulations that establishing whether a payment is a
base erosion payment based solely on the status of the recipient as a
foreign person is inconsistent with the statute's intent of eliminating
base erosion. As a result, deductible payments to a foreign person that
are treated as effectively connected income are subject to tax under
section 871(b) and 882(a) in substantially the same manner as payments
to a U.S. citizen or resident, or a domestic corporation, and, thus,
such payments do not result in base erosion. Thus, such payments are
treated as income to the recipient and subject to U.S. tax,
substantially similar to any payment between related U.S. corporations.
Further, treatment of effectively connected income payments to a
foreign related party would produce different tax results for two
similarly situated U.S. taxpayers. That is, if the taxpayer were to
make a payment to a related U.S. corporation, the payment generally
would not be subject to the BEAT, but if a taxpayer were to make a
payment to a foreign person with respect to its effectively connected
income, it would give rise to BEAT liability, despite the fact that in
both cases the recipients include the payment in U.S. taxable income.
The final regulations retain the same approach as the proposed
regulations. See Sec. 1.59A-3(b)(3)(iii). This approach provides
consistency with the approach in the regulations to determining the
applicable taxpayer for aggregate groups, which is discussed in part
I.D.4.a of this Special Analysis, because this provision excludes from
the definition of a base erosion payment those payments to members of
the aggregate group that are also excluded from the base erosion
percentage because the payments are also within the aggregate group.
The Treasury Department and the IRS considered an alternative of
not providing this exception to the definition of a base erosion
payment, but determined that it would be inconsistent to exclude a
payment to the U.S. branch of a foreign related person from the base
erosion percentage (a condition to the application of the BEAT) but not
also exclude the same payment from the amount of base erosion payments
(a factor in determining the amount of BEAT tax liability).
d. Modified Taxable Income
Modified taxable income is a taxpayer's taxable income for the year
calculated without regard to any base erosion tax benefit or the base
erosion percentage of any allowable net operating loss deductions under
section 172 (net operating loss deduction). As discussed in Part V.A.
of the Summary of Comments and Explanation of Revisions, the proposed
regulations
[[Page 67013]]
provide that modified taxable income is computed under the add-back
method of adding back to taxable income the base erosion tax benefits
and base erosion percentage of any net operating loss deductions. The
regulations do not provide for computing modified taxable income by
recomputing the tax base without base erosion tax benefits under an
approach similar to the alternative minimum tax, which the Act repealed
for corporations. Applying the recomputation method would require
taxpayers to maintain records for separate carryforward balances for
attributes, such as net operating loss deductions and business interest
expense carryovers. These items are limited based on taxable income, so
under the recomputation or alternative minimum tax-approach, there
would most likely be different annual limitations and other
computational differences for regular tax purposes and section 59A
purposes. The final regulations retain the same approach as the
proposed regulations. This add-back approach is expected to be less
costly for taxpayers to apply than the recomputation approach because
under the add-back approach, where amounts are only added to taxable
income, taxpayers will not have to recompute their entire tax return on
a different basis or maintain separate sets of records to track annual
limitations on attributes such as net operating loss carryforwards or
business interest expense carryforwards (and the IRS will not have to
administer such a system). See Part V.A. of the Summary of Comments and
Explanation of Revisions for a detailed discussion of the comments that
were not adopted.
e. Payments to or From Partnerships
As discussed in Part VIII of the Summary of Comments and
Explanation of Revisions section, these final regulations apply the
``aggregate'' approach to base erosion payments involving partnerships,
which is to say that the regulations generally treat the partnership as
an aggregation of its partners, with the partners viewed as entering
into transactions. This aggregate approach is in contrast to the
alternative ``entity'' approach that treats the partnership as an
entity that engages in transactions. Because partnerships are
passthrough entities that are not themselves subject to U.S. income tax
and because the income of the partnership is taxable to the partners in
the partnership, these final regulations apply the aggregate approach
and provide that payments by a corporation to a partnership, and
payments by a partnership to a corporation, are treated in the first
instance as payments to the partners in the partnership and in second
instance as payments by the partners in the partnership. Under the
alternative entity approach that assesses the partnership as a separate
entity, a payment by an applicable taxpayer (corporation) to a related
foreign partnership could be a base erosion payment even if all of the
partners in the partnership are domestic persons.
Under the aggregate approach adopted in these final regulations,
the applicable taxpayer (corporation) that makes a payment to a related
foreign partnership with a partner or partners that are related foreign
parties will determine whether it has made a base erosion payment by
treating the amount as having been paid to each partner of the
partnership. Conversely, also in the absence of this aggregate
approach, a payment by an applicable taxpayer (corporation) to a
related domestic partnership would not be a base erosion payment even
if some or all of the partners in the partnership are foreign related
parties. As with a payment to a related foreign partnership, under the
aggregate approach adopted in these final regulations, the applicable
taxpayer (corporation) that makes a payment to a related domestic
partnership with a partner or partners that are related foreign parties
will determine whether it has made a base erosion payment by treating
the amount as having being paid to each partner of the partnership.
This approach is thus neutral in both preventing potential abuse and
preventing potential over-breadth.
The final regulations retain the same general approach that was
provided in the proposed regulations. See Part VIII of the Summary of
Comments and Explanation of Revisions. The Treasury Department and the
IRS considered an alternative of not providing guidance on transactions
involving partnerships; however, as discussed in this part I.D.4.e,
these final regulations eliminate the distortion that would otherwise
be present if determination of whether a payment is a base erosion
payment is made by reference to the partnership, rather than by
reference to the partners. For example, in the absence of these final
regulations, taxpayers might be incentivized to route payments through
a domestic partnership that is formed by foreign persons as an
intermediary to avoid the BEAT. Conversely, in the absence of the final
regulations, taxpayers would be incentivized to restructure to avoid
making any payments to a foreign partnership that has partners that are
solely domestic because such payment could be inappropriately
classified as a base erosion payment.
f. Anti-Abuse and Reporting Requirements
Section 59A(i) provides the Secretary authority to issue
regulations and other guidance including for the purposes of preventing
the avoidance of the purposes of section 59A. Pursuant to this specific
grant of regulatory authority, Sec. 1.59A-9 provides rules
recharacterizing certain specified transactions as necessary to prevent
the avoidance of section 59A, and provides examples. The Treasury
Department and the IRS have determined that any compliance burdens or
other economic costs created by the anti-abuse provisions are necessary
to further the purposes of section 59A.
These final regulations also provide reporting requirements
necessary to properly administer and enforce section 59A. In
particular, the Treasury Department and the IRS have identified certain
types of information from taxpayers who are applicable taxpayers for
purposes of section 59A that will be required to be reported on Form
5471, Information Return of U.S. Persons With Respect to Certain
Foreign Corporations, Form 5472, Information Return of a 25% Foreign-
Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade
or Business (Under Sections 6038A and 6038C of the Internal Revenue
Code), and a new Form 8991, Tax on Base Erosion Payments of Taxpayers
With Substantial Gross Receipts. The regulations increase record
keeping requirements for taxpayers relative to the baseline because
additional information is to be reported on Form 5472 and Form 8991.
The requirements added by the proposed regulations, however, derive
directly from statutory changes that require information from
applicable taxpayers and are necessary for the effective administration
of section 59A.
II. Paperwork Reduction Act
1. Collections of Information--Forms 8991, 5471, 5472, and 8858
The collections of information in the final regulations with
respect to section 59A are in Sec. Sec. 1.59A-3(b)(3)(i)(C), 1.59A-
3(b)(4)(i)(D), and 1.6038A-2. In response to comments addressing the
notice of proposed rulemaking preceding the final regulations, the
Treasury Department and the IRS have revised the collection of
information with respect to section 6038A. The revised collection of
information with respect to sections 59A and 6038A is in Sec. 1.6038A-
2(b)(7)(ix).
[[Page 67014]]
The collection of information in Sec. 1.59A-6(b)(2)(i) and Sec.
1.6038A-2(b)(7)(ix) requires an applicable taxpayer that makes
qualified derivative payments to report information regarding its
qualified derivative payments on Form 8991 in order for the QDP
exception from base erosion payment status to apply to any particular
payment. In response to comments, Sec. 1.59A-6(b)(2)(i) provides that
a taxpayer satisfies the reporting requirement by reporting the
aggregate amount of all QDPs (rather than the aggregate amount as
determined by type of derivative contract as provided in proposed Sec.
1.6038A-2(b)(7)(ix)(A)) on Form 8991 or its successor form. To comply
with these reporting requirements, taxpayers will need to develop
systems to collect and report the relevant information. To separately
determine the aggregate amount of QDPs by each specific type of
derivative contract would add to the complexity of those systems. That
additional complexity and compliance burden outweighs the utility to
the IRS of receiving that information for each specific type of
derivative contract. Section 1.59A-6(b)(2)(iv) also provides that
during the transition period before Sec. 1.59A-6(b)(2)(i) is
applicable, taxpayers will not be deemed to have failed to satisfy the
reporting requirement if the taxpayer reports the aggregate amount of
qualified derivative payments in good faith. For purposes of the PRA,
the reporting burden associated with Sec. 1.59A-3(b)(4)(i)(D), Sec.
1.59A-6(b)(2)(i) and Sec. 1.6038A-2(b)(7)(ix) will be reflected in the
PRA submission associated with the Form 8991 series (see chart at the
end of this Part II of the Special Analysis section for the status of
the PRA submission for this form).
Tax Form Impacted
------------------------------------------------------------------------
Number of Forms to which the
Collection of information respondents information may be
(estimated) attached
------------------------------------------------------------------------
Sec. 1.59A-3(b)(4)(i)(D) 105,600 Form 8991 series.
election to use-applicable
financial statements.
Sec. 1.59A-6(b)(2)(i) and 105,600 Form 8991 series.
Sec. 1.6038A-2(b)(7)(ix)
requirement to report
qualified derivative
payments.
------------------------------------------------------------------------
CDW.
The information collection requirements pursuant to Sec. 1.59A-
3(b)(3)(i)(C) are discussed further below. The collections of
information pursuant to section 59A, except with respect to information
collected under Sec. 1.59A-3(b)(3)(i)(C), will be conducted by way of
the following:
Form 8991, Tax on Base Erosion Payments of Taxpayers With
Substantial Gross Receipts;
Schedule G to the Form 5471, Information Return of U.S.
Persons With Respect to Certain Foreign Corporations;
Part VIII of the updated Form 5472, Information Return of
a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged
in a U.S. Trade or Business;
Revised Form 8858, Information Return of U.S. Persons With
Respect to Foreign Disregarded Entities.
For purposes of the Paperwork Reduction Act, the reporting burden
associated with the collections of information with respect to section
59A, other than with respect to Sec. 1.59A-3(b)(3)(i)(C), will be
reflected in the IRS Forms 14029 Paperwork Reduction Act Submission,
associated with Forms 5471 (OMB control numbers 1545-0123, and 1545-
0074), 5472 (OMB control number 1545-0123), 8858 (OMB control numbers
1545-0123, 1545-0074, and 1545-1910), and 8991 (OMB control number
1545-0123).
The current status of the Paperwork Reduction Act submissions
related to BEAT is provided in the following table. The BEAT provisions
are included in aggregated burden estimates for the OMB control numbers
listed below which, in the case of 1545-0123, represents a total
estimated burden time, including all other related forms and schedules
for corporations, of 3.157 billion hours and total estimated monetized
costs of $58.148 billion ($2017) and, in the case of 1545-0074, a total
estimated burden time, including all other related forms and schedules
for individuals, of 1.784 billion hours and total estimated monetized
costs of $31.764 billion ($2017). The burden estimates provided in the
OMB control numbers below are aggregate amounts that relate to the
entire package of forms associated with the OMB control number, and
will in the future include but not isolate the estimated burden of only
the BEAT requirements. These numbers are therefore unrelated to the
future calculations needed to assess the burden imposed by the final
regulations. The Treasury Department and IRS urge readers to recognize
that these numbers are duplicates and to guard against overcounting the
burden that international tax provisions imposed prior to the Act. No
burden estimates specific to the final regulations are currently
available. The Treasury Department has not estimated the burden,
including that of any new information collections, related to the
requirements under the final regulations. Those estimates would capture
both changes made by the Act and those that arise out of discretionary
authority exercised in the final regulations. The Treasury Department
and the IRS request comment on all aspects of information collection
burdens related to the final regulations. In addition, when available,
drafts of IRS forms are posted for comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.htm.
----------------------------------------------------------------------------------------------------------------
Form Type of filer OMB No.(s) Status
----------------------------------------------------------------------------------------------------------------
Form 5471 (including Schedule G)...... Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/8/18. Public
Comment period closed on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
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[[Page 67015]]
Individual (NEW Model)... 1545-0074 Limited Scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission for all forms in
3/2019. 60 Day Federal
Register notice not
published yet for full
collection.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
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Form 5472 (including Part VIII)....... Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/11/18. Public
Comment period closed on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
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Form 8858............................. All other Filers (mainly 1545-1910 Published in the Federal
trusts and estates) Register on 10/30/18. Public
(Legacy system). Comment period closed on11/
30/18. ICR in process by the
Treasury Department as of 9/
6/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/30/2018-23644/agency-information-collection-activities-submission-for-omb-review-comment-request-multiple-irs.
-------------------------------------------------------------------------
Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/8/18. Public
Comment period closed on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
-------------------------------------------------------------------------
Individual (NEW Model)... 1545-0074 Limited Scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission for all forms in
3-2019. 60 Day Federal
Register notice not
published yet for full
collection.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
Form 8991............................. Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/11/18. Public
Comment period closed on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
----------------------------------------------------------------------------------------------------------------
Related New or Revised Tax Forms
----------------------------------------------------------------------------------------------------------------
Number of
New Revision of respondents (2018,
existing form estimated)
----------------------------------------------------------------------------------------------------------------
Form 8991.............................................. Y ................ 3,500-4,500
Form 5471, Schedule G.................................. ................ Y 15,000-25,000
Form 5472, Part VIII................................... Y ................ 80,000-100,000
Form 8858.............................................. ................ Y 15,000-25,000
----------------------------------------------------------------------------------------------------------------
The numbers of respondents in the Related New or Revised Tax Forms
table were estimated by Treasury's Office of Tax Analysis based on data
from IRS Compliance Planning and Analytics using tax return data for
tax years 2015 and 2016. Data for Form 8991 represent preliminary
estimates of the total number of taxpayers which may be required to
file the new Form 8991. Only certain large corporate taxpayers with
gross receipts of at least $500 million are expected to file this form.
Data for each of the Forms 5471, 5472, and 8858 represent preliminary
estimates of the total number of taxpayers that are expected to file
these information returns regardless of whether that taxpayer must also
file Form 8991.
The Treasury Department and the IRS project that 3,500-4,500
taxpayers may be applicable taxpayers under the BEAT. This estimate is
based on the number of filers that (1) filed the Form 1120 series of
tax returns (except for the Form 1120-S), (2) filed a Form 5471 or Form
5472, and (3) reported gross receipts of at least $500 million. Because
an applicable taxpayer is defined under section 59A(e)(1)(A) as a
corporation other than a regulated investment company, a real estate
investment trust, or an S corporation, the Treasury Department and the
IRS have determined that taxpayers who filed the Form 1120 series of
tax returns will be most likely to be affected by these proposed
regulations. Additionally, the Treasury Department and the IRS
estimated the number of filers likely to make payments to a foreign
related party based on filers of the Form 1120 series of tax returns
who also filed a Form 5471 or Form 5472 to determine the number of
respondents. Finally, because an applicable taxpayer is defined under
section 59A(e)(1)(B) as a taxpayer with average annual gross receipts
of at least $500 million for the 3-taxable-year period ending with the
preceding taxable year, the Treasury Department and the IRS estimated
the scope of respondents based on the amount of gross receipts reported
by taxpayers filing the Form 1120 series of tax returns.
These projections are based solely on data with respect to the
taxpayer, without taking into account any
[[Page 67016]]
members of the taxpayer's aggregate group. As many as 105,600
additional taxpayers may be applicable taxpayers as a result of being
members of an aggregate group.\6\ This estimate is based on the number
of taxpayers who filed a Form 1120 and also filed a Form 5471 or a Form
5472, but without regard to the gross receipts test.
---------------------------------------------------------------------------
\6\ These estimates are based on current tax filings for taxable
year 2017 and do not yet include the BEAT. At this time, the
Treasury Department and the IRS do not have readily available data
to determine whether a taxpayer that is a member of an aggregate
group will meet all tests to be an applicable taxpayer for purposes
of the BEAT.
---------------------------------------------------------------------------
2. Collection of Information--Sec. 1.59A-3(b)(3)(i)(C)
The information collection requirements pursuant to Sec. 1.59A-
3(b)(3)(i)(C) will be satisfied by the taxpayer maintaining permanent
books and records that are adequate to verify the amount charged for
the services and the total services costs incurred by the renderer,
including a description of the services in question, identification of
the renderer and the recipient of the services, calculation of the
amount of profit mark-up (if any) paid for the services, and sufficient
documentation to allow verification of the methods used to allocate and
apportion the costs to the services.
The collection of information in Sec. 1.59A-3(b)(3)(i)(C) is
mandatory for taxpayers seeking to exclude certain amounts paid or
accrued to a foreign related party for services from treatment as base
erosion payments for purposes of section 59A (the ``SCM exception to
the BEAT''). Taxpayers seeking to rely on the SCM exception to the BEAT
are aggregate groups of corporations with average annual gross receipts
of at least $500 million and that make payments to foreign related
parties. The information required to be maintained will be used by the
IRS for tax compliance purposes.
Estimated total annual reporting burden: 5,000 hours.
Estimated average annual burden hours per respondent: 2.5 hours.
Estimated average cost per respondent ($2017): $238.00.
Estimated number of respondents: 2,000. This estimate is based on
the assumption that only a portion of taxpayers will qualify for the
SCM exception to the BEAT, multiplied by the number of respondents
shown above.
Estimated annual frequency of responses: Once.
Based on these estimates, the annual three-year reporting burden
for those electing the SCM exemption is $0.16 mn/yr ($2017) ($238 x
2,000/3, converted to millions).
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
III. Regulatory Flexibility Act
It is hereby certified that these regulations will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act
(5 U.S.C. chapter 6). This certification is based on the fact that
these regulations will primarily affect aggregate groups of
corporations with average annual gross receipts of at least $500
million and that make payments to foreign related parties. Generally
only large businesses both have substantial gross receipts and make
payments to foreign related parties.
Pursuant to section 7805(f), the proposed regulations preceding
these final regulations (REG-104259-18) were submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on their impact on small business.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
state, local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. In 2019, that threshold is approximately $154 million. This
rule does not include any Federal mandate that may result in
expenditures by state, local, or tribal governments, or by the private
sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. This final rule does not have
federalism implications and does not impose substantial direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive Order.
VI. Congressional Review Act
The Administrator of the Office of Information and Regulatory
Affairs of the Office of Management and Budget has determined that this
is a major rule for purposes of the Congressional Review Act (5 U.S.C.
801 et seq.) (``CRA''). Under section 801(3) of the CRA, a major rule
takes effect 60 days after the rule is published in the Federal
Register. Notwithstanding this requirement, section 808(2) of the CRA
allows agencies to dispense with the requirements of 801 when the
agency for good cause finds that such procedure would be impracticable,
unnecessary, or contrary to the public interest and the rule shall take
effect at such time as the agency promulgating the rule determines.
Pursuant to section 808(2) of the CRA, the Treasury Department and
the IRS find, for good cause, that a 60-day delay in the effective date
is unnecessary and contrary to the public interest. The Treasury
Department and the IRS have determined that the rules in this Treasury
decision (other than the reporting requirements for QDPs in Sec.
1.6038A-2(b)(7), Sec. 1.1502-2(a)(9), and Sec. 1.1502-59A) shall take
effect for taxable years ending on or after December 17, 2018. Section
14401(e) of the Act provides that section 59A applies to base erosion
payments paid or accrued in taxable years beginning after December 31,
2017. This means that the statute is currently effective, and taxpayers
may be required to make payments under section 59A on a U.S. federal
income tax return for 2018 tax years. These final regulations provide
crucial guidance for taxpayers on how to apply the rules of section
59A, correctly calculate their liability under section 59A, and
accurately file their U.S. federal income tax returns. Because the
statute already requires taxpayers to comply with section 59A, a 60-day
delay in the effective date is unnecessary and contrary to the public
interest.
Drafting Information
The principal authors of these final regulations are Azeka J.
Abramoff, Sheila Ramaswamy, and Karen Walny of the Office of Associate
Chief Counsel (International) and Julie Wang and John
[[Page 67017]]
P. Stemwedel of the Office of Associate Chief Counsel (Corporate).
However, other personnel from the Treasury Department and the IRS
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by revising
the entry for Sec. 1.6038A-2 and adding entries for Sec. Sec. 1.59A-
0, 1.59A-1, 1.59A-2, 1.59A-3, 1.59A-4, 1.59A-5, 1.59A-6, 1.59A-7,
1.59A-8, 1.59A-9, 1.59A-10, 1.1502-59A, and 1.1502-100 to read in part
as follows:
Authority: 26 U.S.C. 7805 * * *
* * * * *
Sec. 1.59A-0 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-1 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-2 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-3 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-4 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-5 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-6 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-7 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-8 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-9 also issued under 26 U.S.C. 59A(i).
Sec. 1.59A-10 also issued under 26 U.S.C. 59A(i).
* * * * *
Sec. 1.1502-59A also issued under 26 U.S.C. 1502.
* * * * *
Sec. 1.1502-100 also issued under 26 U.S.C. 1502.
* * * * *
Sec. 1.6038A-2 also issued under 26 U.S.C. 6001, 6038A, and
6038C.
* * * * *
0
Par. 2. Sections 1.59A-0 through 1.59A-10 are added to read as follows:
* * * * *
Sec.
1.59A-0 Table of contents.
1.59A-1 Base erosion and anti-abuse tax.
1.59A-2 Applicable taxpayer.
1.59A-3 Base erosion payments and base erosion tax benefits.
1.59A-4 Modified taxable income.
1.59A-5 Base erosion minimum tax amount.
1.59A-6 Qualified derivative payment.
1.59A-7 Application of base erosion and anti-abuse tax to
partnerships.
1.59A-8 [Reserved]
1.59A-9 Anti-abuse and recharacterization rules.
1.59A-10 Applicability date.
* * * * *
Sec. 1.59A-0 Table of contents.
This section contains a listing of the headings for Sec. Sec.
1.59A-1, 1.59A-2, 1.59A-3, 1.59A-4, 1.59A-5, 1.59A-6, 1.59A-7, 1.59A-8,
1.59A-9, 1.59A-10.
Sec. 1.59A-1 Base erosion and anti-abuse tax.
(a) Purpose.
(b) Definitions.
(1) Aggregate group.
(2) Applicable section 38 credits.
(3) Applicable taxpayer.
(4) Bank.
(5) Base erosion and anti-abuse tax rate.
(6) Business interest expense.
(7) Deduction.
(8) Disallowed business interest expense carryforward.
(9) Domestic related business interest expense.
(10) Foreign person.
(11) Foreign related business interest expense.
(12) Foreign related party.
(13) Gross receipts.
(14) Member of an aggregate group.
(15) Registered securities dealer.
(16) Regular tax liability.
(17) Related party.
(i) In general.
(ii) 25-percent owner.
(iii) Application of section 318.
(18) TLAC long-term debt required amount.
(19) TLAC securities amount.
(20) TLAC security.
(21) Unrelated business interest expense.
Sec. 1.59A-2 Applicable taxpayer.
(a) Scope.
(b) Applicable taxpayer.
(c) Aggregation rules.
(1) In general.
(2) Aggregate group determined with respect to each taxpayer.
(i) In general.
(ii) Reserved.
(3) Taxable year of members of an aggregate group.
(4) Reserved.
(5) Reserved.
(6) Reserved.
(7) Partnerships.
(8) Transition rule for aggregate group members with different
taxable years.
(d) Gross receipts test.
(1) Amount of gross receipts.
(2) Taxpayer not in existence for entire three-year period.
(3) Gross receipts of foreign corporations.
(4) Gross receipts of an insurance company.
(5) Reductions in gross receipts.
(6) Gross receipts of consolidated groups.
(e) Base erosion percentage test.
(1) In general.
(2) Base erosion percentage test for banks and registered
securities dealers.
(i) In general.
(ii) Aggregate groups.
(iii) De minimis exception for banking and registered securities
dealer activities.
(3) Computation of base erosion percentage.
(i) In general.
(ii) Certain items not taken into account in denominator.
(iii) Effect of treaties on base erosion percentage
determination.
(iv) Amounts paid or accrued between members of a consolidated
group.
(v) Deductions and base erosion tax benefits from partnerships.
(vi) Mark-to-market positions.
(vii) Reinsurance losses incurred and claims payments.
(viii) Certain payments that qualify for the effectively
connected income exception and another base erosion payment
exception.
(f) Examples.
(1) Mark-to-market.
(i) Facts.
(ii) Analysis.
(2) [Reserved]
Sec. 1.59A-3 Base erosion payments and base erosion tax benefits.
(a) Scope.
(b) Base erosion payments.
(1) In general.
(2) Operating rules.
(i) In general.
(ii) Amounts paid or accrued in cash and other consideration.
(iii) Transactions providing for net payments.
(iv) Amounts paid or accrued with respect to mark-to-market
position.
(v) Coordination among categories of base erosion payments.
(vi) Certain domestic passthrough entities.
(A) In general.
(B) Amount of base erosion payment.
(C) Specified domestic passthrough.
(D) Specified foreign related party.
(vii) Transfers of property to related taxpayers.
(viii) Reductions to determine gross income.
(ix) Losses recognized on the sale or transfer of property.
(3) Exceptions to base erosion payment.
(i) Certain services cost method amounts.
(A) In general.
(B) Eligibility for the services cost method exception.
(C) Adequate books and records.
(D) Total services cost.
(ii) Qualified derivative payments.
(iii) Effectively connected income.
(A) In general.
(B) Application to certain treaty residents.
(iv) Exchange loss on a section 988 transaction.
(v) Amounts paid or accrued with respect to TLAC securities and
foreign TLAC securities.
(A) In general.
(B) Limitation on exclusion for TLAC securities.
(C) Scaling ratio.
(D) Average domestic TLAC securities amount.
(E) Average TLAC long-term debt required amount.
[[Page 67018]]
(F) Limitation on exclusion for foreign TLAC securities.
(1) In general.
(2) Foreign TLAC long-term debt required amount.
(3) No specified minimum provided by local law.
(4) Foreign TLAC security.
(vi) Amounts paid or accrued in taxable years beginning before
January 1, 2018.
(vii) Business interest carried forward from taxable years
beginning before January 1, 2018.
(viii) Specified nonrecognition transactions.
(A) In general.
(B) Other property transferred to a foreign related party in a
specified nonrecognition transaction.
(C) Other property received from a foreign related party in
certain specified nonrecognition transactions.
(D) Definition of other property
(E) Allocation of other property.
(ix) Reinsurance losses incurred and claims payments.
(A) In general.
(B) Regulated foreign insurance company.
(4) Rules for determining the amount of certain base erosion
payments.
(i) Interest expense allocable to a foreign corporation's
effectively connected income.
(A) Methods described in Sec. 1.882-5.
(B) U.S.-booked liabilities determination.
(C) U.S.-booked liabilities in excess of U.S.-connected
liabilities.
(D) Election to use financial statements.
(E) Coordination with certain tax treaties.
(1) In general.
(2) Hypothetical Sec. 1.882-5 interest expense defined.
(3) Consistency requirement.
(F) Coordination with exception for foreign TLAC securities.
(ii) Other deductions allowed with respect to effectively
connected income.
(iii) Depreciable property.
(iv) Coordination with ECI exception.
(v) Coordination with certain tax treaties.
(A) Allocable expenses.
(B) Internal dealings under certain income tax treaties.
(vi) Business interest expense arising in taxable years
beginning after December 31, 2017.
(c) Base erosion tax benefit.
(1) In general.
(2) Exception to base erosion tax benefit.
(i) In general.
(ii) Branch-level interest tax.
(3) Effect of treaty on base erosion tax benefit.
(4) Application of section 163(j) to base erosion payments.
(i) Classification of payments or accruals of business interest
expense based on the payee.
(A) Classification of payments or accruals of business interest
expense of a corporation.
(B) Classification of payments or accruals of business interest
expense by a partnership.
(C) Classification of payments or accruals of business interest
expense paid or accrued to a foreign related party that is subject
to an exception.
(1) ECI exception.
(2) TLAC interest and interest subject to withholding tax.
(ii) Ordering rules for business interest expense that is
limited under section 163(j)(1) to determine which classifications
of business interest expense are deducted and which classifications
of business interest expense are carried forward.
(A) In general.
(B) Ordering rules for treating business interest expense
deduction and disallowed business interest expense carryforwards as
foreign related business interest expense, domestic related business
interest expense, and unrelated business interest expense.
(1) General ordering rule for allocating business interest
expense deduction between classifications.
(2) Ordering of business interest expense incurred by a
corporation.
(3) Ordering of business interest expense incurred by a
partnership and allocated to a corporate partner.
(d) Examples.
(1) Example 1: Determining a base erosion payment.
(i) Facts.
(ii) Analysis.
(2) Example 2: Interest allocable under Sec. 1.882-5.
(i) Facts.
(ii) Analysis.
(3) Example 3: Interaction with section 163(j).
(i) Facts.
(ii) Analysis.
(A) Classification of business interest.
(B) Ordering rules for disallowed business interest expense
carryforward.
(4) Example 4: Interaction with section 163(j); carryforward.
(i) Facts.
(ii) Analysis.
(A) Classification of business interest.
(B) Ordering rules for disallowed business interest expense
carryforward.
(5) Example 5: Interaction with section 163(j); carryforward.
(i) Facts.
(ii) Analysis.
(6) Example 6: Interaction with section 163(j); partnership.
(i) Facts.
(ii) Partnership level analysis.
(iii) Partner level allocations analysis.
(iv) Partner level allocations for determining base erosion tax
benefits.
(v) Computation of modified taxable income.
(7) Example 7: Transfers of property to related taxpayers.
(i) Facts.
(ii) Analysis.
(A) Year 1.
(B) Year 2.
Sec. 1.59A-4 Modified taxable income.
(a) Scope.
(b) Computation of modified taxable income.
(1) In general.
(2) Modifications to taxable income.
(i) Base erosion tax benefits.
(ii) Certain net operating loss deductions.
(3) Rule for holders of a residual interest in a REMIC.
(c) Examples.
(1) Example 1: Current year loss.
(i) Facts.
(ii) Analysis.
(2) Example 2: Net operating loss deduction.
(i) Facts.
(ii) Analysis.
Sec. 1.59A-5 Base erosion minimum tax amount.
(a) Scope.
(b) Base erosion minimum tax amount.
(1) In general.
(2) Calculation of base erosion minimum tax amount.
(3) Credits that do not reduce regular tax liability.
(i) Taxable years beginning on or before December 31, 2025.
(ii) Taxable years beginning after December 31, 2025.
(c) Base erosion and anti-abuse tax rate.
(1) In general.
(i) Calendar year 2018.
(ii) Calendar years 2019 through 2025.
(iii) Calendar years after 2025.
(2) Increased rate for banks and registered securities dealers.
(i) In general.
(ii) De minimis exception to increased rate for banks and
registered securities dealers.
(3) Application of section 15 to tax rates in section 59A.
(i) New tax.
(ii) Change in tax rate pursuant to section 59A(b)(1)(A).
(iii) Change in rate pursuant to section 59A(b)(2).
Sec. 1.59A-6 Qualified derivative payment.
(a) Scope.
(b) Qualified derivative payment.
(1) In general.
(2) Reporting requirements.
(i) In general.
(ii) Failure to satisfy the reporting requirement.
(iii) Reporting of aggregate amount of qualified derivative
payments.
(iv) Transition period for qualified derivative payment
reporting.
(3) Amount of any qualified derivative payment.
(i) In general.
(ii) Net qualified derivative payment that includes a payment
that is a base erosion payment.
(c) Exceptions for payments otherwise treated as base erosion
payments.
(d) Derivative defined.
(1) In general.
(2) Exceptions.
(i) Direct interest.
(ii) Insurance contracts.
(iii) Securities lending and sale-repurchase transactions.
(A) Multi-step transactions treated as financing.
(B) Special rule for payments associated with the cash
collateral provided in a securities lending transaction or
substantially similar transaction.
(C) Anti-abuse exception for certain transactions that are the
economic equivalent of substantially unsecured cash borrowing.
(3) American depository receipts.
(e) Examples.
[[Page 67019]]
(1) Example 1: Notional principal contract as QDP.
(i) Facts.
(ii) Analysis.
(2) Example 2: Securities lending anti-abuse rule.
(i) Facts.
(ii) Analysis.
Sec. 1.59A-7 Application of base erosion and anti-abuse tax to
partnerships.
(a) Scope.
(b) Application of section 59A to partnerships.
(c) Base erosion payment.
(1) Payments made by or to a partnership.
(2) Transfers of certain property.
(3) Transfers of a partnership interest.
(i) In general.
(ii) Transfers of a partnership interest by a partner.
(iii) Certain issuances of a partnership interest by a
partnership.
(iv) Partnership interest transfers defined.
(4) Increased basis from a distribution.
(5) Operating rules applicable to base erosion payments.
(i) Single payment characterized as separate transactions.
(ii) Ordering rule with respect to transfers of a partnership
interest.
(iii) Consideration for base erosion payment or property
resulting in base erosion tax benefits.
(iv) Non-cash consideration.
(d) Base erosion tax benefit for partners.
(1) In general.
(2) Exception for base erosion tax benefits of certain small
partners.
(i) In general.
(ii) Attribution.
(e) Other rules for applying section 59A to partnerships.
(1) Partner's distributive share.
(2) Gross receipts.
(i) In general.
(ii) Foreign corporation.
(3) Registered securities dealers.
(4) Application of sections 163(j) and 59A(c)(3) to partners.
(5) Tiered partnerships.
(f) Foreign related party.
(g) Examples.
(1) Facts.
(2) Examples.
(i) Example 1: Contributions to a partnership on partnership
formation.
(A) Facts.
(B) Analysis.
(ii) Example 2: Section 704(c) and remedial allocations.
(A) Facts.
(B) Analysis.
(iii) Example 3: Sale of a partnership interest without a
section 754 election.
(A) Facts.
(B) Analysis.
(iv) Example 4: Sale of a partnership interest with section 754
election.
(A) Facts.
(B) Analysis.
(v) Example 5: Purchase of depreciable property from a
partnership.
(A) Facts.
(B) Analysis.
(vi) Example 6: Sale of a partnership interest to a second
partnership.
(A) Facts.
(B) Analysis.
(vii) Example 7: Distribution of cash by a partnership to a
foreign related party.
(A) Facts.
(B) Analysis.
(viii) Example 8: Distribution of property by a partnership to a
taxpayer.
(A) Facts.
(B) Analysis.
(ix) Example 9: Distribution of property by a partnership in
liquidation of a foreign related party's interest.
(A) Facts.
(B) Analysis.
Sec. 1.59A-8 [Reserved]
Sec. 1.59A-9 Anti-abuse and recharacterization rules.
(a) Scope.
(b) Anti-abuse rules.
(1) Transactions involving unrelated persons, conduits, or
intermediaries.
(2) Transactions to increase the amount of deductions taken into
account in the denominator of the base erosion percentage
computation.
(3) Transactions to avoid the application of rules applicable to
banks and registered securities dealers.
(4) Nonrecognition transactions.
(c) Examples.
(1) Facts.
(2) Example 1: Substitution of payments that are not base
erosion payments for payments that otherwise would be base erosion
payments through a conduit or intermediary.
(i) Facts.
(ii) Analysis.
(3) Example 2: Alternative transaction to base erosion payment.
(i) Facts.
(ii) Analysis.
(4) Example 3: Alternative financing source.
(i) Facts.
(ii) Analysis.
(5) Example 4: Alternative financing source that is a conduit.
(i) Facts.
(ii) Analysis.
(6) Example 5: Intermediary acquisition.
(i) Facts.
(ii) Analysis.
(7) Example 6: Offsetting transactions to increase the amount of
deductions taken into account in the denominator of the base erosion
percentage computation.
(i) Facts.
(ii) Analysis.
(8) Example 7: Ordinary course transactions that increase the
amount of deductions taken into account in the denominator of the
base erosion percentage computation.
(i) Facts.
(ii) Analysis.
(9) Example 8: Transactions to avoid the application of rules
applicable to banks and registered securities dealers.
(i) Facts.
(ii) Analysis.
(10) Example 9: Transactions that do not avoid the application
of rules applicable to banks and registered securities dealers.
(i) Facts.
(ii) Analysis.
(11) Example 10: Acquisition of depreciable property in a
nonrecognition transaction.
(i) Facts.
(ii) Analysis.
(12) Example 11: Transactions between related parties with a
principal purpose of increasing the adjusted basis of property.
(i) Facts.
(ii) Analysis.
Sec. 1.59A-10 Applicability date.
Sec. 1.59A-1 Base erosion and anti-abuse tax.
(a) Purpose. This section and Sec. Sec. 1.59A-2 through 1.59A-10
(collectively, the ``section 59A regulations'') provide rules under
section 59A to determine the amount of the base erosion and anti-abuse
tax. Paragraph (b) of this section provides definitions applicable to
the section 59A regulations. Section 1.59A-2 provides rules regarding
how to determine whether a taxpayer is an applicable taxpayer. Section
1.59A-3 provides rules regarding base erosion payments and base erosion
tax benefits. Section 1.59A-4 provides rules for calculating modified
taxable income. Section 1.59A-5 provides rules for calculating the base
erosion minimum tax amount. Section 1.59A-6 provides rules relating to
qualified derivative payments. Section 1.59A-7 provides rules regarding
the application of section 59A to partnerships. Section 1.59A-8 is
reserved for rules regarding the application of section 59A to certain
expatriated entities. Section 1.59A-9 provides anti-abuse rules to
prevent avoidance of section 59A. Finally, Sec. 1.59A-10 provides the
applicability date for the section 59A regulations.
(b) Definitions. For purposes of this section and Sec. Sec. 1.59A-
2 through 1.59A-10, the following terms have the meanings provided in
this paragraph (b).
(1) Aggregate group. The term aggregate group means the group of
corporations determined by--
(i) Identifying a controlled group of corporations as defined in
section 1563(a), except that the phrase ``more than 50 percent'' is
substituted for ``at least 80 percent'' each place it appears in
section 1563(a)(1) and the determination is made without regard to
sections 1563(a)(4) and (e)(3)(C), and
(ii) Once the controlled group of corporations is determined,
excluding foreign corporations except with regard to income that is, or
is treated as, effectively connected with the conduct of a trade or
business in the United States under an applicable provision of the
Internal Revenue Code or
[[Page 67020]]
regulations published under 26 CFR chapter I. Notwithstanding the
foregoing, if a foreign corporation is subject to tax on a net basis
pursuant to an applicable income tax treaty of the United States, it is
excluded from the controlled group of corporations except with regard
to income taken into account in determining its net taxable income.
(2) Applicable section 38 credits. The term applicable section 38
credits means the credits allowed under section 38 for the taxable year
that are properly allocable to--
(i) The low-income housing credit determined under section 42(a),
(ii) The renewable electricity production credit determined under
section 45(a), and
(iii) The investment credit determined under section 46, but only
to the extent properly allocable to the energy credit determined under
section 48.
(3) Applicable taxpayer. The term applicable taxpayer means a
taxpayer that meets the requirements set forth in Sec. 1.59A-2(b).
(4) Bank. The term bank has the meaning provided in section 581.
(5) Base erosion and anti-abuse tax rate. The term base erosion and
anti-abuse tax rate means the percentage that the taxpayer applies to
its modified taxable income for the taxable year to calculate its base
erosion minimum tax amount. See Sec. 1.59A-5(c) for the base erosion
and anti-abuse tax rate applicable for the relevant taxable year.
(6) Business interest expense. The term business interest expense,
with respect to a taxpayer and a taxable year, has the meaning provided
in Sec. 1.163(j)-1(b)(2).
(7) Deduction. The term deduction means any deduction allowable
under chapter 1 of subtitle A of the Internal Revenue Code.
(8) Disallowed business interest expense carryforward. The term
disallowed business interest expense carryforward has the meaning
provided in Sec. 1.163(j)-1(b)(9).
(9) Domestic related business interest expense. The term domestic
related business interest expense for any taxable year is the
taxpayer's business interest expense paid or accrued to a related party
that is not a foreign related party.
(10) Foreign person. The term foreign person means any person who
is not a United States person. For purposes of the preceding sentence,
a United States person has the meaning provided in section 7701(a)(30),
except that any individual who is a citizen of any possession of the
United States (but not otherwise a citizen of the United States) and
who is not a resident of the United States is not a United States
person. See Sec. 1.59A-7(b) for rules applicable to partnerships.
(11) Foreign related business interest expense. The term foreign
related business interest expense for any taxable year is the
taxpayer's business interest expense paid or accrued to a foreign
related party.
(12) Foreign related party. The term foreign related party means a
foreign person, as defined in paragraph (b)(10) of this section, that
is a related party, as defined in paragraph (b)(17) of this section,
with respect to the taxpayer. In addition, for purposes of Sec. 1.59A-
3(b)(4)(v)(B) (relating to internal dealings under certain income tax
treaties), a foreign related party also includes the foreign
corporation's home office or a foreign branch of the foreign
corporation. See Sec. 1.59A-7(b), (c), and (f) for rules applicable to
partnerships.
(13) Gross receipts. The term gross receipts has the meaning
provided in Sec. 1.448-1T(f)(2)(iv).
(14) Member of an aggregate group. The term member of an aggregate
group means a corporation that is included in an aggregate group, as
defined in paragraph (b)(1) of this section.
(15) Registered securities dealer. The term registered securities
dealer means any dealer as defined in section 3(a)(5) of the Securities
Exchange Act of 1934 that is registered, or required to be registered,
under section 15 of the Securities Exchange Act of 1934.
(16) Regular tax liability. The term regular tax liability has the
meaning provided in section 26(b).
(17) Related party--(i) In general. A related party, with respect
to an applicable taxpayer, is--
(A) Any 25-percent owner of the taxpayer;
(B) Any person who is related (within the meaning of section 267(b)
or 707(b)(1)) to the taxpayer or any 25-percent owner of the taxpayer;
or
(C) A controlled taxpayer within the meaning of Sec. 1.482-1(i)(5)
together with, or with respect to, the taxpayer.
(ii) 25-percent owner. With respect to any corporation, a 25-
percent owner means any person who owns at least 25 percent of--
(A) The total voting power of all classes of stock of the
corporation entitled to vote; or
(B) The total value of all classes of stock of the corporation.
(iii) Application of section 318. Section 318 applies for purposes
of paragraphs (b)(17)(i) and (ii) of this section, except that--
(A) ``10 percent'' is substituted for ``50 percent'' in section
318(a)(2)(C); and
(B) Section 318(a)(3)(A) through (C) are not applied so as to
consider a United States person as owning stock that is owned by a
person who is not a United States person.
(18) TLAC long-term debt required amount. The term TLAC long-term
debt required amount means the specified minimum amount of debt that is
required pursuant to 12 CFR 252.162(a).
(19) TLAC securities amount. The term TLAC securities amount is the
sum of the adjusted issue prices (as determined for purposes of Sec.
1.1275-1(b)) of all TLAC securities issued and outstanding by the
taxpayer, without regard to whether interest thereunder would be a base
erosion payment absent Sec. 1.59A-3(b)(3)(v).
(20) TLAC security. The term TLAC security means an eligible
internal debt security, as defined in 12 CFR 252.161.
(21) Unrelated business interest expense. The term unrelated
business interest expense for any taxable year is the taxpayer's
business interest expense paid or accrued to a party that is not a
related party.
Sec. 1.59A-2 Applicable taxpayer.
(a) Scope. This section provides rules for determining whether a
taxpayer is an applicable taxpayer. Paragraph (b) of this section
defines an applicable taxpayer. Paragraph (c) of this section provides
rules for determining whether a taxpayer is an applicable taxpayer by
reference to the aggregate group of which the taxpayer is a member.
Paragraph (d) of this section provides rules regarding the gross
receipts test. Paragraph (e) of this section provides rules regarding
the base erosion percentage test. Paragraph (f) of this section
provides examples illustrating the rules of this section.
(b) Applicable taxpayer. For purposes of section 59A, a taxpayer is
an applicable taxpayer with respect to any taxable year if the
taxpayer--
(1) Is a corporation, but not a regulated investment company, a
real estate investment trust, or an S corporation;
(2) Satisfies the gross receipts test of paragraph (d) of this
section; and
(3) Satisfies the base erosion percentage test of paragraph (e) of
this section.
(c) Aggregation rules--(1) In general. Solely for purposes of this
section and Sec. 1.59A-4, a taxpayer that is a member of an aggregate
group determines its gross receipts and its base erosion percentage on
the basis of the aggregate group. For these purposes, transactions that
occur between members of the taxpayer's aggregate group that were
members of the aggregate group as of the time of the transaction are
not taken into account. In the case of a foreign
[[Page 67021]]
corporation that is a member of an aggregate group, only transactions
that occur between members of the aggregate group and that relate to
income effectively connected with, or treated as effectively connected
with, the conduct of a trade or business in the United States are not
taken into account for this purpose. In the case of a foreign
corporation that is a member of an aggregate group and that is subject
to tax on a net basis pursuant to an applicable income tax treaty of
the United States, only transactions that occur between members of the
aggregate group and that relate to income that is taken into account in
determining its net taxable income are not taken into account for this
purpose.
(2) Aggregate group determined with respect to each taxpayer--(i)
In general. Solely for purposes of this section, an aggregate group is
determined with respect to each taxpayer. As a result, the aggregate
group of one taxpayer may be different than the aggregate group of
another member of the taxpayer's aggregate group.
(ii) [Reserved]
(3) Taxable year of members of an aggregate group. Solely for
purposes of this section, a taxpayer that is a member of an aggregate
group measures the gross receipts and base erosion percentage of the
aggregate group for a taxable year by reference to the taxpayer's gross
receipts, base erosion tax benefits, and deductions for the taxable
year and the gross receipts, base erosion tax benefits, and deductions
of each member of the aggregate group for the taxable year of the
member that ends with or within the taxpayer's taxable year.
(4) through (6) [Reserved]
(7) Partnerships. For the treatment of partnerships for purposes of
determining gross receipts and base erosion tax benefits, see Sec.
1.59A-7(e)(2) and (d), respectively.
(8) Transition rule for aggregate group members with different
taxable years. If the taxpayer has a different taxable year than
another member of the taxpayer's aggregate group (other member), and
the other member is eligible for the exception in Sec. 1.59A-
3(b)(3)(vi) (amounts paid or accrued in taxable years beginning before
January 1, 2018) with respect to a taxable year ending with or within
the taxpayer's taxable year (``excepted taxable year''), the excepted
taxable year of the other member is not taken into account for purposes
of paragraph (e) of this section. This rule applies solely for purposes
of determining whether a taxpayer is an applicable taxpayer under this
section.
(d) Gross receipts test--(1) Amount of gross receipts. A taxpayer,
or the aggregate group of which the taxpayer is a member, satisfies the
gross receipts test of this section if it has average annual gross
receipts of at least $500,000,000 for the three-taxable-year period
ending with the preceding taxable year.
(2) Taxpayer not in existence for entire three-year period. If a
taxpayer was not in existence for the entire three-year period referred
to in paragraph (d)(1) of this section, the taxpayer determines a gross
receipts average for the period that it was in existence (which
includes gross receipts in the current year).
(3) Gross receipts of foreign corporations. With respect to any
foreign corporation, only gross receipts that are taken into account in
determining income that is, or is treated as, effectively connected
with the conduct of a trade or business within the United States are
taken into account for purposes of paragraph (d)(1) of this section. In
the case of a foreign corporation that is a member of an aggregate
group and that is subject to tax on a net basis pursuant to an
applicable income tax treaty of the United States, the foreign
corporation includes only gross receipts that are attributable to
transactions taken into account in determining its net taxable income.
(4) Gross receipts of an insurance company. Solely for purposes of
this section, for any corporation that is subject to tax under
subchapter L or any corporation that would be subject to tax under
subchapter L if that corporation were a domestic corporation, gross
receipts are reduced by return premiums (within the meaning of section
803(a)(1)(B) and section 832(b)(4)(A)), but are not reduced by any
reinsurance premiums paid or accrued.
(5) Reductions in gross receipts. For purposes of this section,
gross receipts for any taxable year are reduced by returns and
allowances made during that taxable year.
(6) Gross receipts of consolidated groups. For purposes of this
section, the gross receipts of a consolidated group are determined by
aggregating the gross receipts of all of the members of the
consolidated group. See Sec. 1.1502-59A(b).
(e) Base erosion percentage test--(1) In general. A taxpayer, or
the aggregate group of which the taxpayer is a member, satisfies the
base erosion percentage test if its base erosion percentage is three
percent or higher.
(2) Base erosion percentage test for banks and registered
securities dealers--(i) In general. A taxpayer that is a member of an
affiliated group (as defined in section 1504(a)(1)) that includes a
bank (as defined in Sec. 1.59A-1(b)(4)) or a registered securities
dealer (as defined in section Sec. 1.59A-1(b)(15)) satisfies the base
erosion percentage test if its base erosion percentage is two percent
or higher.
(ii) Aggregate groups. An aggregate group of which a taxpayer is a
member and that includes a bank or a registered securities dealer that
is a member of an affiliated group (as defined in section 1504(a)(1))
is subject to the base erosion percentage threshold described in
paragraph (e)(2)(i) of this section.
(iii) De minimis exception for banking and registered securities
dealer activities. An aggregate group that includes a bank or a
registered securities dealer that is a member of an affiliated group
(as defined in section 1504(a)(1)) is not treated as including a bank
or registered securities dealer for purposes of paragraph (e)(2)(i) of
this section for a taxable year, if, for that taxable year, the total
gross receipts of the aggregate group attributable to the bank or the
registered securities dealer (or attributable to all of the banks and
registered securities dealers in the group, if more than one) represent
less than two percent of the total gross receipts of the aggregate
group, as determined under paragraph (d) of this section. When there is
no aggregate group, a consolidated group that includes a bank or a
registered securities dealer is not treated as including a bank or
registered securities dealer for purposes of paragraph (e)(2)(i) of
this section for a taxable year, if, for that taxable year, the total
gross receipts of the consolidated group attributable to the bank or
the registered securities dealer (or attributable to all of the banks
or registered securities dealers in the group, if more than one)
represent less than two percent of the total gross receipts of the
consolidated group, as determined under paragraph (d) of this section.
(3) Computation of base erosion percentage--(i) In general. The
taxpayer's base erosion percentage for any taxable year is determined
by dividing--
(A) The aggregate amount of the taxpayer's (or in the case of a
taxpayer that is a member of an aggregate group, the aggregate group's)
base erosion tax benefits (as defined in Sec. 1.59A-3(c)(1)) for the
taxable year, by
(B) The sum of--
(1) The aggregate amount of the deductions (including deductions
for base erosion tax benefits described in Sec. 1.59A-3(c)(1)(i) and
base erosion tax benefits described in Sec. 1.59A-3(c)(1)(ii))
allowable to the taxpayer (or in the case
[[Page 67022]]
of a taxpayer that is a member of an aggregate group, any member of the
aggregate group) under chapter 1 of Subtitle A for the taxable year;
(2) The base erosion tax benefits described in Sec. 1.59A-
3(c)(1)(iii) with respect to any premiums or other consideration paid
or accrued by the taxpayer (or in the case of a taxpayer that is a
member of an aggregate group, any member of the aggregate group) to a
foreign related party for any reinsurance payment taken into account
under sections 803(a)(1)(B) or 832(b)(4)(A) for the taxable year; and
(3) Any amount paid or accrued by the taxpayer (or in the case of a
taxpayer that is a member of an aggregate group, any member of the
aggregate group) resulting in a reduction of gross receipts described
in Sec. 1.59A-3(c)(1)(iv) for the taxable year.
(ii) Certain items not taken into account in denominator. Except as
provided in paragraph (e)(3)(viii) of this section, the amount under
paragraph (e)(3)(i)(B) of this section is determined by not taking into
account--
(A) Any deduction allowed under section 172, 245A, or 250 for the
taxable year;
(B) Any deduction for amounts paid or accrued for services to which
the exception described in Sec. 1.59A-3(b)(3)(i) applies;
(C) Any deduction for qualified derivative payments that are not
treated as base erosion payments by reason of Sec. 1.59A-3(b)(3)(ii);
(D) Any exchange loss within the meaning of Sec. 1.988-2 from a
section 988 transaction as described in Sec. 1.988-1(a)(1) that is not
treated as a base erosion payment by reason of Sec. 1.59A-3(b)(3)(iv);
(E) Any deduction for amounts paid or accrued to foreign related
parties with respect to TLAC securities and foreign TLAC securities
that are not treated as base erosion payments by reason of Sec. 1.59A-
3(b)(3)(v);
(F) Any reinsurance losses incurred and claims payments described
in Sec. 1.59A-3(b)(3)(ix); and
(G) Any deduction not allowed in determining taxable income for the
taxable year.
(iii) Effect of treaties on base erosion percentage determination.
See Sec. 1.59A-3(c)(2) and (3).
(iv) Amounts paid or accrued between members of a consolidated
group. See Sec. 1.1502-59A(b).
(v) Deductions and base erosion tax benefits from partnerships. See
Sec. 1.59A-7(b), (d), and (e).
(vi) Mark-to-market positions. For any position with respect to
which the taxpayer (or in the case of a taxpayer that is a member of an
aggregate group, a member of the aggregate group) applies a mark-to-
market method of accounting for U.S. federal income tax purposes, the
taxpayer must determine its gain or loss with respect to that position
for any taxable year by combining all items of income, gain, loss, or
deduction arising with respect to the position during the taxable year,
regardless of how each item arises (including from a payment, accrual,
or mark) for purposes of paragraph (e)(3) of this section. See
paragraph (f)(1) of this section (Example 1) for an illustration of
this rule. For purposes of section 59A, a taxpayer computes its losses
resulting from positions subject to a mark-to-market regime under the
Internal Revenue Code based on a single mark for the taxable year on
the earlier of the last business day of the taxpayer's taxable year and
the disposition (whether by sale, offset, exercise, termination,
expiration, maturity, or other means) of the position, regardless of
how frequently a taxpayer marks to market for other purposes. See Sec.
1.59A-3(b)(2)(iii) for the application of this rule for purposes of
determining the amount of base erosion payments.
(vii) Reinsurance losses incurred and claims payments. Except as
provided in paragraph (e)(3)(ii)(F) of this section, amounts paid for
losses incurred (as defined in section 832(b)(5)) and claims and
benefits under section 805(a)(1) are taken into account for purposes of
paragraph (e)(3)(i)(B)(1) of this section.
(viii) Certain payments that qualify for the effectively connected
income exception and another base erosion payment exception. Subject to
paragraph (c) of this section (transactions that occur between members
of the taxpayer's aggregate group), a payment that qualifies for the
effectively connected income exception described in Sec. 1.59A-
3(b)(3)(iii) and either the service cost method exception described in
Sec. 1.59A-3(b)(3)(i), the qualified derivative payment exception
described in Sec. 1.59A-3(b)(3)(ii), or the TLAC exception described
in Sec. 1.59A-3(b)(3)(v) is not subject to paragraph (e)(3)(ii)(B),
(C), or (E) of this section and those amounts are included in the
denominator of the base erosion percentage if the foreign related party
who received the payment is not a member of the aggregate group.
(f) Examples. The following examples illustrate the rules of
this section.
(1) Mark-to-market--(i) Facts. (A) Foreign Parent (FP) is a
foreign corporation that owns all of the stock of domestic
corporation (DC). FP is a foreign related party of DC under Sec.
1.59A-1(b)(12). DC is a registered securities dealer that does not
hold any securities for investment. On January 1 of year 1, DC
enters into two interest rate swaps for a term of two years, one
with unrelated Customer A as the counterparty (position A) and one
with unrelated Customer B as the counterparty (position B). Each of
the swaps provides for semiannual periodic payments to be made or
received on June 30 and December 31. No party makes any payment to
any other party upon initiation of either of the swaps (that is,
they are entered into at-the-money). DC is required to mark-to-
market positions A and B for U.S. federal income tax purposes. DC is
a calendar year taxpayer.
(B) For position A in year 1, DC makes a payment of $150x on
June 30, and receives a payment of $50x on December 31. There are no
other payments in year 1. On December 31, position A has a value to
DC of $110x (that is, position A is in-the-money by $110x).
(C) For position B in year 1, DC receives a payment of $120x on
June 30, and makes a payment of $30x on December 31. There are no
other payments in year 1. On December 31, position B has a value to
DC of ($130x) (that is, position B is out-of-the-money by $130x).
(ii) Analysis. (A) With respect to position A, based on the
total amount of payments made and received in year 1, DC has a net
deduction of $100x. In addition, DC has a mark-to-market gain of
$110x. As described in paragraph (e)(3)(vi) of this section, the
mark-to-market gain of $110x is combined with the net deduction of
$100x resulting from the payments. Therefore, with respect to
position A, DC has a gain of $10x, and thus has no deduction in year
1 for purposes of section 59A.
(B) With respect to position B, based on the total amount of
payments made and received in year 1, DC has net income of $90x. In
addition, DC has a mark-to-market loss of $130x. As described in
paragraph (e)(3)(vi) of this section, the mark-to-market loss of
$130x is combined with the net income of $90x resulting from the
payments. Therefore, with respect to position B, DC has a loss of
$40x, and thus has a $40x deduction in year 1 for purposes of
section 59A.
(2) [Reserved]
Sec. 1.59A-3 Base erosion payments and base erosion tax benefits.
(a) Scope. This section provides definitions and related rules
regarding base erosion payments and base erosion tax benefits.
Paragraph (b) of this section provides definitions and rules regarding
base erosion payments. Paragraph (c) of this section provides rules for
determining the amount of base erosion tax benefits. Paragraph (d) of
this section provides examples illustrating the rules described in this
section.
(b) Base erosion payments--(1) In general. Except as provided in
paragraph (b)(3) of this section, a base erosion payment means--
(i) Any amount paid or accrued by the taxpayer to a foreign related
party of the taxpayer and with respect to which a deduction is
allowable under chapter 1
[[Page 67023]]
of subtitle A of the Internal Revenue Code;
(ii) Any amount paid or accrued by the taxpayer to a foreign
related party of the taxpayer in connection with the acquisition of
property by the taxpayer from the foreign related party if the
character of the property is subject to the allowance for depreciation
(or amortization in lieu of depreciation);
(iii) Any premium or other consideration paid or accrued by the
taxpayer to a foreign related party of the taxpayer for any reinsurance
payments that are taken into account under section 803(a)(1)(B) or
832(b)(4)(A); or
(iv) Any amount paid or accrued by the taxpayer that results in a
reduction of the gross receipts of the taxpayer if the amount paid or
accrued is with respect to--
(A) A surrogate foreign corporation, as defined in section
59A(d)(4)(C)(i), that is a related party of the taxpayer (but only if
the corporation first became a surrogate foreign corporation after
November 9, 2017); or
(B) A foreign person that is a member of the same expanded
affiliated group, as defined in section 59A(d)(4)(C)(ii), as the
surrogate foreign corporation.
(2) Operating rules--(i) In general. The determination of the
amount paid or accrued, and the identity of the payor and recipient of
any amount paid or accrued, is made under general U.S. federal income
tax law.
(ii) Amounts paid or accrued in cash and other consideration. For
purposes of paragraph (b)(1) of this section, an amount paid or accrued
includes an amount paid or accrued using any form of consideration,
including cash, property, stock, a partnership interest, or the
assumption of a liability, including any exchange transaction. A
distribution of property that is not part of an exchange (such as a
distribution under section 301, without regard to whether section
301(c)(1), (c)(2), or (c)(3) applies), is not received with respect to
an amount paid or accrued and does not give rise to a base erosion
payment. In contrast, a redemption of stock by a corporation within the
meaning of section 317(b) (such as a redemption described in section
302(a) or (d) or section 306(a)(2)), or a transaction in which there is
an exchange for stock (such as a section 304 or section 331
transaction), is an amount paid or accrued by the shareholder to the
corporation (or by the acquiring corporation to the transferor in a
section 304 transaction), without regard to the treatment of such
transaction for U.S. federal income tax purposes. See paragraph
(b)(3)(viii) of this section for an exception for specified
nonrecognition transactions (as defined in paragraph (b)(3)(viii)(A) of
this section).
(iii) Transactions providing for net payments. Except as otherwise
provided in paragraph (b)(2)(iv) of this section or as permitted by the
Internal Revenue Code or the regulations, the amount of any base
erosion payment is determined on a gross basis, regardless of any
contractual or legal right to make or receive payments on a net basis.
For this purpose, a right to make or receive payments on a net basis
permits the parties to a transaction or series of transactions to
settle obligations by offsetting any amounts to be paid by one party
against amounts owed by that party to the other party. For example, any
premium or other consideration paid or accrued by a taxpayer to a
foreign related party for any reinsurance payments is not reduced by or
netted against other amounts owed to the taxpayer from the foreign
related party or by reserve adjustments or other returns.
(iv) Amounts paid or accrued with respect to mark-to-market
position. For any transaction with respect to which the taxpayer
applies the mark-to-market method of accounting for U.S. federal income
tax purposes, the rules set forth in Sec. 1.59A-2(e)(3)(vi) apply to
determine the amount of the base erosion payment.
(v) Coordination among categories of base erosion payments. A
payment that does not satisfy the criteria of one category of base
erosion payment may be a base erosion payment described in one of the
other categories.
(vi) Certain domestic passthrough entities--(A) In general. If a
taxpayer pays or accrues an amount that would be a base erosion payment
except for the fact that the payment is made to a specified domestic
passthrough, then the taxpayer will be treated as making a base erosion
payment to each specified foreign related party for purposes of section
59A and Sec. Sec. 1.59A-2 through 1.59A-10. This rule has no effect on
the taxation of the specified domestic passthrough under subchapter J
or subchapter M of the Code (as applicable).
(B) Amount of base erosion payment. The amount of the base erosion
payment is equal to the lesser of the amount paid or accrued by the
taxpayer to or for the benefit of the specified domestic passthrough
and the amount of the deduction allowed under section 561, 651, or 661
to the specified domestic passthrough with respect to amounts paid,
credited, distributed, deemed distributed, or required to be
distributed to a specified foreign related party.
(C) Specified domestic passthrough. For purposes of this paragraph
(b)(2)(vi), specified domestic passthrough means:
(1) A domestic trust that is not a grantor trust under subpart E of
subchapter J of chapter 1 of the Code (``domestic trust'') and which
domestic trust is allowed a deduction under section 651 or section 661
with respect to amounts paid, credited, or required to be distributed
to a specified foreign related party;
(2) A real estate investment trust (as defined in Sec. 1.856-1(a))
that pays, or is deemed to pay, a dividend to a specified foreign
related party for which a deduction is allowed under section 561; or
(3) A regulated investment company (as defined in Sec. 1.851-1(a))
that pays, or is deemed to pay, a dividend to a specified foreign
related party for which a deduction is allowed under section 561.
(D) Specified foreign related party. For purposes of this paragraph
(b)(2)(vi), specified foreign related party means, with respect to a
specified domestic passthrough, any foreign related party of a taxpayer
that is a direct or indirect beneficiary or shareholder of the
specified domestic passthrough.
(vii) Transfers of property to related taxpayers. If a taxpayer
owns property of a character subject to the allowance for depreciation
(or amortization in lieu of depreciation) with respect to which
paragraph (c)(1)(ii) of this section applies, and the taxpayer sells,
exchanges, or otherwise transfers the property to another taxpayer that
is a member of an aggregate group that includes the taxpayer (taking
into account Sec. 1.59A-7), any deduction for depreciation (or
amortization in lieu of depreciation) by the transferee taxpayer
remains subject to paragraph (c)(1)(ii) of this section to the same
extent the amounts would have been so subject in the hands of the
transferor. See paragraph (d)(7) of this section (Example 7) for an
illustration of this rule.
(viii) Reductions to determine gross income. For purposes of
paragraphs (b)(1)(i) and (ii) of this section, any amount resulting in
a reduction to determine gross income under section 61, including an
amount properly treated as cost of goods sold under the Code, is not a
base erosion payment.
(ix) Losses recognized on the sale or transfer of property. If a
taxpayer recognizes a loss on a sale or transfer of property to a
foreign related party, the loss recognized with respect to the sale or
transfer is not a deduction that would cause the payment to be treated
as a base erosion payment under paragraph
[[Page 67024]]
(b)(1)(i) of this section. However, if a taxpayer uses property to make
a payment to a foreign related party and the payment otherwise meets
the requirements of paragraph (b)(1) of this section, the amount of the
payment that is treated as a base erosion payment equals the fair
market value of the property at the time of the transfer.
(3) Exceptions to base erosion payment. Paragraph (b)(1) of this
section does not apply to the types of payments or accruals described
in paragraphs (b)(3)(i) through (ix) of this section.
(i) Certain services cost method amounts--(A) In general. Amounts
paid or accrued by a taxpayer to a foreign related party for services
that meet the requirements in paragraph (b)(3)(i)(B) of this section,
but only to the extent of the total services cost of those services.
Thus, any amount paid or accrued to a foreign related party in excess
of the total services cost of services eligible for the services cost
method exception (the mark-up component) remains a base erosion
payment. For this purpose, services are an activity as defined in Sec.
1.482-9(l)(2) performed by a foreign related party (the renderer) that
provides a benefit as defined in Sec. 1.482-9(l)(3) to the taxpayer
(the recipient).
(B) Eligibility for the services cost method exception. To be
eligible for the services cost method exception, all of the
requirements of Sec. 1.482-9(b) must be satisfied, except that:
(1) The requirements of Sec. 1.482-9(b)(5) do not apply for
purposes of determining eligibility for the service cost method
exception in this section; and
(2) Adequate books and records must be maintained as described in
paragraph (b)(3)(i)(C) of this section, instead of as described in
Sec. 1.482-9(b)(6).
(C) Adequate books and records. Permanent books of account and
records must be maintained for as long as the costs with respect to the
services are incurred by the renderer. The books and records must be
adequate to permit verification by the Commissioner of the amount
charged for the services and the total services costs incurred by the
renderer, including a description of the services in question,
identification of the renderer and the recipient of the services,
calculation of the amount of profit mark-up (if any) paid for the
services, and sufficient documentation to allow verification of the
methods used to allocate and apportion the costs to the services in
question in accordance with Sec. 1.482-9(k). For example, where a
renderer incurs costs that are attributable to performing a service for
the taxpayer that includes services eligible for the services cost
method exception under this section (regardless of whether the taxpayer
determined its payments for those services based on the services cost
method) and another service that is not eligible for the services cost
method exception, books and records must be maintained that show, among
other things: the total amount of costs that are attributable to each
of those services, the method chosen under Sec. 1.482-9(k) to
apportion the costs between the service eligible for the services cost
method under this section and the other service, and the application of
that method in calculating the amount eligible for the services cost
method exception. This paragraph (b)(3)(i)(C) does not affect the
recordkeeping requirements imposed by any other provision, including
Sec. 1.6001-1.
(D) Total services cost. For purposes of this section, total
services cost has the same meaning as total services costs in Sec.
1.482-9(j).
(ii) Qualified derivative payments. Any qualified derivative
payment as described in Sec. 1.59A-6.
(iii) Effectively connected income--(A) In general. Except as
provided in paragraph (b)(3)(iii)(B) of this section, amounts paid or
accrued to a foreign related party that are subject to U.S. federal
income taxation as income that is, or is treated as, effectively
connected with the conduct of a trade or business in the United States
under an applicable provision of the Internal Revenue Code or
regulations. Paragraph (b)(3)(iii) of this section applies only if the
taxpayer receives a withholding certificate on which the foreign
related party claims an exemption from withholding under section 1441
or 1442 because the amounts are effectively connected income.
(B) Application to certain treaty residents. If a foreign related
party determines its taxable income pursuant to the business profits
provisions of an applicable income tax treaty, amounts paid or accrued
to the foreign related party that are taken into account in determining
its taxable income.
(iv) Exchange loss on a section 988 transaction. Any exchange loss
within the meaning of Sec. 1.988-2 from a section 988 transaction
described in Sec. 1.988-1(a)(1) that is an allowable deduction and
that results from a payment or accrual by the taxpayer to a foreign
related party.
(v) Amounts paid or accrued with respect to TLAC securities and
foreign TLAC securities--(A) In general. Except as provided in
paragraph (b)(3)(v)(B) and (F) of this section, amounts paid or accrued
to foreign related parties with respect to TLAC securities and foreign
TLAC securities.
(B) Limitation on exclusion for TLAC securities. The amount
excluded under paragraph (b)(3)(v)(A) of this section is no greater
than the product of the scaling ratio and amounts paid or accrued to
foreign related parties with respect to TLAC securities for which a
deduction is allowed.
(C) Scaling ratio. For purposes of this paragraph (b)(3)(v), the
scaling ratio for a taxable year of a taxpayer is a fraction the
numerator of which is 115 percent of the average TLAC long-term debt
required amount and the denominator of which is the average TLAC
securities amount. The scaling ratio may in no event be greater than
one.
(D) Average TLAC securities amount. The average TLAC securities
amount for a taxable year is the average of the TLAC securities amounts
for the year, computed at regular time intervals in accordance with
this paragraph. The TLAC securities amount used in calculating the
average TLAC securities amount is computed on a monthly basis.
(E) Average TLAC long-term debt required amount. The average TLAC
long-term debt required amount for a taxable year is the average of the
TLAC long-term debt required amounts, computed on a monthly basis.
(F) Limitation on exclusion for foreign TLAC securities--(1) In
general. The amount excluded under paragraph (b)(3)(v)(A) of this
section for foreign TLAC securities is limited to the extent that
interest deducted by a U.S. trade or business or permanent
establishment with respect to foreign TLAC securities exceeds the
interest expense associated with the foreign TLAC long-term debt
required amount, applying the scaling ratio principles set forth under
paragraphs (b)(3)(v)(B) through (E) of this section.
(2) Foreign TLAC long-term debt required amount. For purposes of
paragraph (b)(3)(v) of this section, the term foreign TLAC long-term
debt required amount means in the case of a trade or business or a
permanent establishment in the United States, the lesser of--
(i) The specified minimum amount of debt, if any, required pursuant
to a bank regulatory requirement imposed under the laws or regulations
of a foreign country that are comparable to 12 CFR 252.160-167; or
(ii) The specified minimum amount of debt, if any, that would be
required pursuant to 12 CFR 252.162(a) if the trade or business or
permanent establishment were a U.S. person (as determined under Federal
Reserve regulations).
[[Page 67025]]
(3) No specified minimum provided by local law. For purposes of
paragraph (b)(3)(v)(F)(2)(ii) of this section, if the bank regulatory
requirements imposed under the laws or regulations of a foreign country
do not specify a minimum amount, the limitation for purposes of
paragraph (b)(3)(v)(F)(2) of this section is determined by reference
solely to paragraph (b)(3)(v)(F)(2)(ii) of this section.
(4) Foreign TLAC security. For purposes of paragraph (b)(3)(v) of
this section, the term foreign TLAC security means an internal debt
security issued under a bank regulatory requirement imposed under the
laws or regulations of a foreign country that is comparable to 12 CFR
252.160-167. The laws or regulations of a foreign country are
comparable to 12 CFR 252.160-167 if the requirement is imposed by a
Financial Stability Board member state and those laws or regulations
are substantially consistent with TLAC standards of the Financial
Stability Board.
(vi) Amounts paid or accrued in taxable years beginning before
January 1, 2018. Any amount paid or accrued in taxable years beginning
before January 1, 2018.
(vii) Business interest carried forward from taxable years
beginning before January 1, 2018. Any disallowed business interest
described in section 163(j)(2) that is carried forward from a taxable
year beginning before January 1, 2018.
(viii) Specified nonrecognition transactions--(A) In general.
Subject to paragraph (b)(3)(viii)(B) and (C) of this section, any
amount transferred to, or exchanged with, a foreign related party
pursuant to a transaction to which sections 332, 351, 355, or 368 apply
(``specified nonrecognition transaction''). See Sec. 1.59A-9(b)(4) for
anti-abuse rules.
(B) Other property transferred to a foreign related party in a
specified nonrecognition transaction. If a taxpayer transfers other
property (as defined in paragraph (b)(3)(viii)(D) of this section) to a
foreign related party pursuant to a specified nonrecognition
transaction, the other property is treated as an amount paid or accrued
to which paragraph (b)(3) of this section does not apply, regardless of
whether gain is recognized on the transaction.
(C) Other property received from a foreign related party in certain
specified nonrecognition transactions. If, in a transaction described
in section 351, 355, or 368, the taxpayer transfers property and
receives other property (as defined in paragraph (b)(3)(viii)(D) of
this section) from a foreign related party, the property transferred by
the taxpayer is treated as an amount paid or accrued to which paragraph
(b)(3) of this section does not apply, regardless of whether gain is
recognized on the transaction.
(D) Definition of other property. Solely for purposes of this
paragraph (b)(3)(viii), the term other property has the meaning of the
phrase ``other property or money'' as used in section 351(b), with
respect to a transaction to which section 351 applies, and as used in
sections 356(a)(1)(B) and 361(b), with respect to a transaction to
which sections 355 or 368 apply, as applicable, including liabilities
treated as money under section 357(b). However, the term other property
does not include the sum of any money and the fair market value of any
other property to which section 361(b)(3) applies. The term other
property also includes liabilities that are assumed by the taxpayer in
the specified nonrecognition transaction, but only to the extent of the
amount of gain recognized under section 357(c).
(E) Allocation of other property. Other property is treated as
exchanged for property in a specified nonrecognition transaction in a
manner consistent with U.S. federal income tax law. For purposes making
the allocation under this paragraph (b)(3)(viii)(E), liabilities
described in paragraph (b)(3)(viii)(D) of this section are treated as
money received.
(ix) Reinsurance losses incurred and claims payments--(A) In
general. Any amounts paid by a taxpayer subject to tax under subchapter
L to a foreign related party that is a regulated insurance company
under a reinsurance contract between the taxpayer and the regulated
foreign insurance company for losses incurred (as defined in section
832(b)(5)) and claims and benefits under section 805(a)(1), to the
extent that the amounts paid or accrued are properly allocable to
amounts required to be paid by the regulated foreign insurance company
(or indirectly through another regulated foreign insurance company),
pursuant to an insurance, annuity, or reinsurance contract, to a person
other than a related party. For purposes of this paragraph (b)(3)(ix),
the determination of whether a contract is an insurance contract or an
annuity contract is made without regard to sections 72(s), 101(f),
817(h), and 7702, provided that the contract is regulated as a life
insurance or annuity contract in its jurisdiction of issuance and no
policyholder, insured, annuitant or beneficiary with respect to the
contract is a United States person.
(B) Regulated foreign insurance company. The term regulated foreign
insurance company means any foreign corporation which--
(1) Is subject to regulation as an insurance (or reinsurance)
company by the country in which the corporation is created, organized,
or maintains its registered office, and is licensed, authorized, or
regulated by the applicable insurance regulatory body for that country
to sell insurance, annuity, or reinsurance contracts to persons other
than related parties in that country, and
(2) Would be subject to tax under subchapter L if it were a
domestic corporation.
(4) Rules for determining the amount of certain base erosion
payments. The following rules apply in determining the amount that is a
base erosion payment.
(i) Interest expense allocable to a foreign corporation's
effectively connected income--(A) Methods described in Sec. 1.882-5. A
foreign corporation that has interest expense allocable under section
882(c) to income that is, or is treated as, effectively connected with
the conduct of a trade or business within the United States applying
the method described in Sec. 1.882-5(b) through (d) or the method
described in Sec. 1.882-5(e) has base erosion payments under paragraph
(b)(1)(i) of this section for the taxable year equal to the sum of--
(1) The interest expense on a liability described in Sec. 1.882-
5(a)(1)(ii)(A) or (B) (direct allocations) that is paid or accrued by
the foreign corporation to a foreign related party;
(2) The interest expense on U.S.-booked liabilities, as described
in Sec. 1.882-5(d)(2), determined by taking into account paragraph
(b)(4)(i)(B) of this section, that is paid or accrued by the foreign
corporation to a foreign related party; and
(3) The interest expense on U.S.-connected liabilities, as
described in Sec. 1.882-5(d) or 1.882-5(e), in excess of interest
expense on U.S.-booked liabilities as described in Sec. 1.882-5(d)(2),
if any (hereafter, excess U.S.-connected liabilities), multiplied by a
fraction, the numerator of which is the foreign corporation's average
worldwide interest expense due to a foreign related party, and the
denominator of which is the foreign corporation's average total
worldwide interest expense. The numerator and denominator of this
fraction are determined by translating interest expense into the
functional currency of the foreign corporation using any reasonable
method, consistently applied. Any interest expense that is interest
expense on a U.S.-booked liability or is subject to a direct allocation
is excluded from both
[[Page 67026]]
the numerator and the denominator of the fraction.
(B) U.S.-booked liabilities determination. For purposes of
paragraph (b)(4)(i)(A) of this section, the determination of the
interest expense on U.S.-booked liabilities, as described in Sec.
1.882-5(d)(2), is made without regard to whether the foreign
corporation applies the method described in Sec. 1.882-5(b) through
(d) or the method described in Sec. 1.882-5(e) for purposes of
determining interest expense.
(C) U.S.-booked liabilities in excess of U.S.-connected
liabilities. For purposes of paragraph (b)(4)(i)(A)(2) of this section,
if a foreign corporation has U.S.-booked liabilities, as described in
Sec. 1.882-5(d)(2), in excess of U.S.-connected liabilities, as
described in Sec. 1.882-5(d) or Sec. 1.882-5(e), the foreign
corporation applies the scaling ratio pro-rata to all interest expense
on U.S.-booked liabilities consistent with Sec. 1.882-5(d)(4) for
purposes of determining the amount of allocable interest expense on
U.S.-booked liabilities that is a base erosion payment. This paragraph
(b)(4)(i)(C) applies without regard to whether the foreign corporation
applies the method described in Sec. 1.882-5(b) through (d) or the
method described in Sec. 1.882-5(e) for purposes of determining its
interest expense.
(D) Election to use financial statements. A foreign corporation may
elect to calculate the fraction described in paragraph (b)(4)(i)(A)(3)
of this section on the basis of its applicable financial statement
rather than U.S. tax principles. For purposes of this section, an
applicable financial statement has the meaning provided in section
451(b)(3). The applicable financial statement must be the applicable
financial statement of the foreign corporation, not a consolidated
applicable financial statement. A foreign corporation makes this
election in accordance with the requirements of Form 8991 (or
successor).
(E) Coordination with certain tax treaties--(1) In general. If a
foreign corporation elects to determine its taxable income pursuant to
business profits provisions of an income tax treaty rather than
provisions of the Internal Revenue Code, or the regulations published
under 26 CFR chapter I, for determining effectively connected income,
and the foreign corporation does not apply Sec. 1.882-5 to allocate
interest expense to a permanent establishment, then paragraph
(b)(4)(i)(A) through (D) of this section applies to determine the
amount of hypothetical Sec. 1.882-5 interest expense that is a base
erosion payment under paragraph (b)(1) of this section. Interest
expense allowed to the permanent establishment in excess of the
hypothetical Sec. 1.882-5 interest expense, if any, is treated as an
amount paid or accrued by the permanent establishment to the foreign
corporation's home office or to another branch of the foreign
corporation and is a base erosion payment to the extent that the
payment or accrual is described under paragraph (b)(1) of this section.
(2) Hypothetical Sec. 1.882-5 interest expense defined. The
hypothetical Sec. 1.882-5 interest expense is equal to the amount of
interest expense that would have been allocable under section 882(c) to
income that is, or is treated as, effectively connected with the
conduct of a trade or business within the United States if the foreign
corporation determined interest expense in accordance with section
Sec. 1.882-5. However, the hypothetical Sec. 1.882-5 interest expense
shall not exceed the amount of interest expense allowed to the
permanent establishment.
(3) Consistency requirement. For purposes of determining the amount
described in paragraph (b)(4)(i)(E)(2) of this section and applying
paragraph (b)(4)(i)(A) through (D) of this section, the elections of
Sec. 1.882-5 must be applied consistently and are subject to the rules
and limitations of Sec. 1.882-5, including limitations on the time
period in which an election may be made or revoked. If a foreign
corporation otherwise meets the requirements for making or revoking an
election under Sec. 1.882-5, then solely for purposes of this section,
the foreign corporation is treated as making or revoking the election
in accordance with the requirements of Form 8991 (or successor) and its
instructions.
(F) Coordination with exception for foreign TLAC securities. For
purposes of paragraph (b)(4)(i)(A) of this section, amounts paid or
accrued to a foreign related party with respect to securities that are
eligible for the foreign TLAC exception in paragraph (b)(3)(v) of this
section are not treated as paid to a foreign related party.
(ii) Other deductions allowed with respect to effectively connected
income. A deduction allowed under Sec. 1.882-4 for an amount paid or
accrued by a foreign corporation to a foreign related party (including
a deduction for an amount apportioned in part to effectively connected
income and in part to income that is not effectively connected income)
is a base erosion payment under paragraph (b)(1) of this section.
(iii) Depreciable property. Any amount paid or accrued by a foreign
corporation to a foreign related party of the taxpayer in connection
with the acquisition of property by the foreign corporation from the
foreign related party if the character of the property is subject to
the allowance for depreciation (or amortization in lieu of
depreciation) is a base erosion payment to the extent the property so
acquired is used, or held for use, in the conduct of a trade or
business within the United States.
(iv) Coordination with ECI exception. For purposes of paragraph
(b)(4) of this section, amounts paid or accrued to a foreign related
party treated as effectively connected income (or, in the case of a
foreign related party that determines taxable income pursuant to the
business profits provisions of an applicable income tax treaty, such
amounts that are taken into account in determining taxable income) are
not treated as paid to a foreign related party.
(v) Coordination with certain tax treaties--(A) Allocable expenses.
Except as provided in paragraph (b)(4)(i)(E) of this section with
respect to interest, if a foreign corporation determines its taxable
income on a net basis pursuant to an applicable income tax treaty
rather than provisions of the Internal Revenue Code, or the regulations
published under 26 CFR chapter I, for determining effectively connected
income, then the foreign corporation must determine whether each
allowable deduction is a base erosion payment under paragraph (b)(1) of
this section.
(B) Internal dealings under certain income tax treaties. Except as
provided in paragraph (b)(4)(i)(E) of this section with respect to
interest, if, pursuant to the terms of an applicable income tax treaty,
a foreign corporation determines the profits attributable to a
permanent establishment based on the assets used, risks assumed, and
functions performed by the permanent establishment, then any deduction
attributable to any amount paid or accrued (or treated as paid or
accrued) by the permanent establishment to the foreign corporation's
home office or to another branch of the foreign corporation (an
``internal dealing'') is a base erosion payment to the extent that the
payment or accrual is described under paragraph (b)(1) of this section.
(vi) Business interest expense arising in taxable years beginning
after December 31, 2017. Any disallowed business interest expense
described in section 163(j)(2) that resulted from a payment or accrual
to a foreign related party that first arose in a taxable year beginning
after December 31, 2017, is treated as a base erosion payment under
paragraph (b)(1)(i) of this section in the year that the business
interest expense
[[Page 67027]]
initially arose. See paragraph (c)(4) of this section for rules that
apply when business interest expense is limited under section 163(j)(1)
in order to determine whether the disallowed business interest is
attributed to business interest expense paid to a person that is not a
related party, a foreign related party, or a domestic related party.
(c) Base erosion tax benefit--(1) In general. Except as provided in
paragraph (c)(2) of this section, a base erosion tax benefit means:
(i) In the case of a base erosion payment described in paragraph
(b)(1)(i) of this section, any deduction that is allowed under chapter
1 of subtitle A of the Internal Revenue Code for the taxable year with
respect to that base erosion payment;
(ii) In the case of a base erosion payment described in paragraph
(b)(1)(ii) of this section, any deduction allowed under chapter 1 of
subtitle A of the Internal Revenue Code for the taxable year for
depreciation (or amortization in lieu of depreciation) with respect to
the property acquired with that payment;
(iii) In the case of a base erosion payment described in paragraph
(b)(1)(iii) of this section, any reduction under section 803(a)(1)(B)
in the gross amount of premiums and other consideration on insurance
and annuity contracts for premiums and other consideration arising out
of indemnity reinsurance, or any deduction under section 832(b)(4)(A)
from the amount of gross premiums written on insurance contracts during
the taxable year for premiums paid for reinsurance; or
(iv) In the case of a base erosion payment described in paragraph
(b)(1)(iv) of this section, any reduction in gross receipts with
respect to the payment in computing gross income of the taxpayer for
the taxable year for purposes of chapter 1 of subtitle A of the
Internal Revenue Code.
(2) Exception to base erosion tax benefit--(i) In general. Except
as provided in paragraph (c)(3) of this section, any base erosion tax
benefit attributable to any base erosion payment is not taken into
account as a base erosion tax benefit if tax is imposed on that payment
under section 871 or 881, and the tax has been deducted and withheld
under section 1441 or 1442. If a payment is taken into account for
purposes of the fraction described in paragraph (b)(4)(i)(A)(3) of this
section, and tax is imposed on the payment under section 871 or 881,
and the tax has been deducted and withheld under section 1441 or 1442,
the payment is treated as not paid or accrued to a foreign related
party.
(ii) Branch-level interest tax. Except as provided in paragraph
(c)(3) of this section, any base erosion tax benefit of a foreign
corporation attributable to any base erosion payment determined under
paragraph (b)(4)(i)(A)(3) of this section or attributable to interest
expense in excess of the hypothetical section 1.882-5 interest expense
determined under paragraph (b)(4)(i)(E)(1) of this section is not taken
into account as a base erosion tax benefit to the extent of the amount
of excess interest, as defined in Sec. 1.884-4(a)(2), if any, on which
tax is imposed on the foreign corporation under section 884(f) and
Sec. 1.884-4, if the tax is properly reported on the foreign
corporation's income tax return and paid in accordance with Sec.
1.884-4(a)(2)(iv).
(3) Effect of treaty on base erosion tax benefit. If any treaty
between the United States and any foreign country reduces the rate of
tax imposed by section 871 or 881, the amount of base erosion tax
benefit that is not taken into account under paragraph (c)(2) of this
section is equal to the amount of the base erosion tax benefit before
the application of paragraph (c)(2) of this section multiplied by a
fraction of--
(i) The rate of tax imposed under the treaty; over
(ii) The rate of tax imposed without regard to the treaty.
(4) Application of section 163(j) to base erosion payments--(i)
Classification of payments or accruals of business interest expense
based on the payee. The following rules apply for corporations and
partnerships:
(A) Classification of payments or accruals of business interest
expense of a corporation. For purposes of this section, in the year
that business interest expense of a corporation is paid or accrued the
business interest expense is classified as foreign related business
interest expense, domestic related business interest expense, or
unrelated business interest expense.
(B) Classification of payments or accruals of business interest
expense by a partnership. For purposes of this section, in the year
that business interest expense of a partnership is paid or accrued, the
business interest expense that is allocated to a partner is classified
separately with respect to each partner in the partnership as foreign
related business interest expense, domestic related business interest
expense, or unrelated business interest expense.
(C) Classification of payments or accruals of business interest
expense paid or accrued to a foreign related party that is subject to
an exception--(1) ECI exception. For purposes of paragraph (c)(4)(i)(A)
and (B) of this section, business interest expense paid or accrued to a
foreign related party to which the exception in paragraph (b)(3)(iii)
of this section (effectively connected income) applies is classified as
domestic related business interest expense.
(2) TLAC interest and interest subject to withholding tax. For
purposes of paragraph (c)(4)(i)(A) and (B) of this section, if the
exception in paragraph (b)(3)(v) of this section (TLAC securities) or
paragraph (c)(2) or (3) of this section (withholding tax) applies to
business interest expense paid or accrued to a foreign related party,
that business interest expense remains classified as foreign related
business interest expense, and retains its classification as eligible
for those exceptions, on a pro-rata basis with other foreign related
business interest expense.
(ii) Ordering rules for business interest expense that is limited
under section 163(j)(1) to determine which classifications of business
interest expense are deducted and which classifications of business
interest expense are carried forward--(A) In general. Section 163(j)
and the regulations published under 26 CFR chapter I provide a
limitation on the amount of business interest expense allowed as a
deduction in a taxable year by a corporation or a partner in a
partnership. In the case of a corporation with a disallowed business
interest expense carryforward, the regulations under section 163(j)
determine the ordering of the business interest expense deduction that
is allowed on a year-by-year basis by reference first to business
interest expense incurred in the current taxable year and then to
disallowed business interest expense carryforwards from prior years. To
determine the amount of base erosion tax benefit under paragraph (c)(1)
of this section, this paragraph (c)(4)(ii) sets forth ordering rules
that determine the amount of the deduction of business interest expense
allowed under section 163(j) that is classified as paid or accrued to a
foreign related party for purposes of paragraph (c)(1)(i) of this
section. This paragraph (c)(4)(ii) also sets forth similar ordering
rules that apply to disallowed business interest expense carryforwards
for which a deduction is permitted under section 163(j) in a later
year.
(B) Ordering rules for treating business interest expense deduction
and disallowed business interest expense carryforwards as foreign
related
[[Page 67028]]
business interest expense, domestic related business interest expense,
and unrelated business interest expense--(1) General ordering rule for
allocating business interest expense deduction between classifications.
For purposes of paragraph (c)(1) of this section, if a deduction for
business interest expense is not subject to the limitation under
section 163(j)(1) in a taxable year, the deduction is treated first as
foreign related business interest expense and domestic related business
interest expense (on a pro-rata basis), and second as unrelated
business interest expense. The same principle applies to business
interest expense of a partnership that is deductible at the partner
level under Sec. 1.163(j)-6(f).
(2) Ordering of business interest expense incurred by a
corporation. If a corporation's business interest expense deduction
allowed for any taxable year is attributable to business interest
expense paid or accrued in that taxable year and to disallowed business
interest expense carryforwards from prior taxable years, the ordering
of business interest expense deduction provided in paragraph
(c)(4)(ii)(B)(1) of this section among the classifications described
therein applies separately for the carryforward amount from each
taxable year, following the ordering set forth in Sec. 1.163(j)-
5(b)(2). Corresponding adjustments to the classification of disallowed
business interest expense carryforwards are made consistent with this
year-by-year approach. For purposes of section 59A and this section, an
acquiring corporation in a transaction described in section 381(a) will
succeed to and take into account the classification of any disallowed
business interest expense carryforward. See Sec. 1.381(c)(20)-1.
(3) Ordering of business interest expense incurred by a partnership
and allocated to a corporate partner. For a corporate partner in a
partnership that is allocated a business interest expense deduction
under Sec. 1.163(j)-6(f), the ordering rule provided in paragraph
(c)(4)(ii)(B)(1) of this section applies separately to the corporate
partner's allocated business interest expense deduction from the
partnership; that deduction is not comingled with the business interest
expense deduction addressed in paragraph (c)(4)(ii)(B)(1) or (2) of
this section or the corporate partner's items from any other
partnership. Similarly, when a corporate partner in a partnership is
allocated excess business interest expense from a partnership under the
rules set forth in Sec. 1.163(j)-6(f) and the excess interest expense
becomes deductible to the corporate partner, that partner applies the
ordering rule provided in paragraph (c)(4)(ii)(B)(1) of this section
separately to that excess interest expense on a year-by-year basis.
Corresponding adjustments to the classification of disallowed business
interest expense carryforwards are made consistent with this year-by-
year and partnership-by-partnership approach.
(d) Examples. The following examples illustrate the application of
this section. For purposes of all the examples, assume that the
taxpayer is an applicable taxpayer and all payments apply to a taxable
year beginning after December 31, 2017.
(1) Example 1: Determining a base erosion payment--(i) Facts. FP
is a foreign corporation that owns all of the stock of FC, a foreign
corporation, and DC, a domestic corporation. FP has a trade or
business in the United States with effectively connected income
(USTB). DC owns FDE, a foreign disregarded entity. DC pays interest
to FDE and FC. FDE pays interest to USTB. All interest paid by DC to
FC and by FDE to USTB is deductible by DC in the current year for
regular income tax purposes. FDE also acquires depreciable property
from FP during the taxable year. FP's income from the sale of the
depreciable property is not effectively connected with the conduct
of FP's trade or business in the United States. DC and FP (based
only on the activities of USTB) are applicable taxpayers under Sec.
1.59A-2(b).
(ii) Analysis. The payment of interest by DC to FC is a base
erosion payment under paragraph (b)(1)(i) of this section because
the payment is made to a foreign related party and the interest
payment is deductible. The payment of interest by DC to FDE is not a
base erosion payment because the transaction is not a payment to a
foreign person and the transaction is not a deductible payment. With
respect to the payment of interest by FDE to USTB, if FP's USTB
treats the payment of interest by FDE to USTB as income that is
effectively connected with the conduct of a trade or business in the
United States pursuant to section 864 or as profits attributable to
a U.S. permanent establishment of a tax treaty resident, and if DC
receives a withholding certificate from FP with respect to the
payment, then the exception in paragraph (b)(3)(iii) of this section
applies. Accordingly, the payment from DC, through FDE, to USTB is
not a base erosion payment even though the payment is to the USTB of
FP, a foreign related party. The acquisition of depreciable property
by DC, through FDE, from FP is a base erosion payment under
paragraph (b)(1)(ii) of this section because there is a payment to a
foreign related party in connection with the acquisition by the
taxpayer of property of a character subject to the allowance for
depreciation and the exception in paragraph (b)(3)(iii) of this
section does not apply because FP's income from the sale of the
depreciable property is not effectively connected with the conduct
of FP's trade or business in the United States. See Sec. 1.59A-2
for the application of the aggregation rule with respect to DC and
FP's USTB.
(2) Example 2: Interest allocable under Sec. 1.882-5--(i)
Facts. FC, a foreign corporation, has income that is effectively
connected with the conduct of a trade or business within the United
States. FC determines its interest expense under the three-step
process described in Sec. 1.882-5(b) through (d) with a total
interest expense of $125x. The total interest expense is comprised
of interest expense of $100x on U.S.- booked liabilities ($60x paid
to a foreign related party and $40x paid to unrelated persons) and
$25x of interest on excess U.S.-connected liabilities. FC has
average worldwide interest expense (not including interest expense
on U.S.-booked liabilities) of $500x, of which $100x is interest
expense paid to a foreign related party. FC is an applicable
taxpayer with respect to its effectively connected income. Assume
all of the interest expense is deductible in the current taxable
year and that none of the interest is subject to the effectively
connected income exception in paragraph (b)(3)(iii) of this section.
(ii) Analysis. Under paragraph (b)(4)(i) of this section, the
total amount of interest expense determined under Sec. 1.882-5 that
is a base erosion payment is $65x ($60x + 5x). FC has $60x of
interest on U.S.-booked liabilities that is paid to a foreign
related party and that is treated as a base erosion payment under
paragraph (b)(4)(i)(A)(2) of this section. Additionally, $5x of the
$25x of interest expense on excess U.S.-connected liabilities is
treated as a base erosion payment under paragraph (b)(4)(i)(A)(3) of
this section ($25x * ($100x/$500x)).
(3) Example 3: Interaction with section 163(j)--(i) Facts.
Foreign Parent (FP) is a foreign corporation that owns all of the
stock of DC, a domestic corporation that is an applicable taxpayer.
DC does not conduct a utility trade or business as described in
section 163(j)(7)(A)(iv), an electing real property trade or
business as described in section 163(j)(7)(B), or an electing
farming business as described in section 163(j)(7)(C). In Year 1, DC
has adjusted taxable income, as defined in section 163(j)(8), of
$1000x and pays the following amounts of business interest expense:
$420x that is paid to unrelated Bank, and $360x that is paid to FP.
DC does not earn any business interest income or incur any floor
plan financing interest expense in Year 1. None of the exceptions in
paragraph (b)(3) of this section apply, and the interest is not
subject to withholding.
(ii) Analysis--(A) Classification of business interest. In Year
1, DC is permitted to deduct only $300x of business interest expense
under section 163(j)(1) ($1000x x 30%). Paragraph (c)(4)(ii)(B) of
this section provides that for purposes of paragraph (c)(1) of this
section the deduction is treated first as foreign related business
interest expense and domestic related business interest expense
(here, only FP); and second as unrelated business interest expense
(Bank). As a result, the $300x of business interest expense that is
permitted under section 163(j)(1) is treated entirely as the
business interest paid to the related foreign party, FP. All of DC's
$300x deductible interest is treated as an add-back to modified
taxable income in the Year 1
[[Page 67029]]
taxable year for purposes of Sec. 1.59A-4(b)(2)(i).
(B) Ordering rules for disallowed business interest expense
carryforward. Under section 163(j)(2), the $480x of disallowed
business interest ($420x + $360x-$300x) is carried forward to the
subsequent year. Under paragraph (c)(4)(ii)(B)(1) and (2) of this
section, the disallowed business interest carryforward is
correspondingly treated first as unrelated business interest
expense, and second pro-rata as foreign related business interest
expense and domestic related business interest expense. As a result,
$420x of the $480x disallowed business interest expense carryforward
is treated first as business interest expense paid to Bank and the
remaining $60x of the $480x disallowed business interest expense
carryforward is treated as interest paid to FP and as an add-back to
modified taxable income.
(4) Example 4: Interaction with section 163(j); carryforward--
(i) Facts. The facts are the same as in paragraph (d)(3) of this
section (the facts in Example 3), except that in addition, in Year
2, DC has adjusted taxable income of $250x, and pays the following
amounts of business interest expense: $50x that is paid to unrelated
Bank, and $45x that is paid to FP. DC does not earn any business
interest income or incur any floor plan financing interest expense
in Year 2. None of the exceptions in paragraph (b)(3) of this
section apply.
(ii) Analysis--(A) Classification of business interest. In Year
2, for purposes of section 163(j)(1), DC is treated as having paid
or accrued total business interest expense of $575x, consisting of
$95x business interest expense actually paid in Year 2 and $480x of
business interest expense that is carried forward from Year 1. DC is
permitted to deduct $75x of business interest expense in Year 2
under the limitation in section 163(j)(1) ($250x x 30%). Section
1.163(j)-5(b)(2) provides that, for purposes of section 163(j), the
allowable business interest expense is first attributed to amounts
paid or accrued in the current year, and then attributed to amounts
carried over from earlier years on a first-in-first-out basis from
the earliest year. Accordingly, the $75x of deductible business
interest expense is deducted entirely from the $95x business
interest expense incurred in Year 2 for section 163(j) purposes.
Because DC's business interest expense deduction is limited under
section 163(j)(1) and because DC's total business interest expense
is attributable to more than one taxable year, paragraph
(c)(4)(ii)(B)(2) of this section provides that the ordering rule in
paragraph (c)(4)(ii)(B)(1) of this section is applied separately to
each annual amount of section 163(j) disallowed business interest
expense carryforward. With respect to the Year 2 layer, which is
deducted first, paragraph (c)(4)(ii)(B) of this section provides
that, for purposes of paragraph (c)(1) of this section, the Year 2
$75x deduction is treated first as foreign related business interest
expense and domestic related business interest expense (here, only
FP, $45x); and second as unrelated business interest expense (Bank,
$30x). Consequentially, all of the $45x deduction of business
interest expense that was paid to FP in Year 2 is treated as a base
erosion tax benefit and an add-back to modified taxable income for
the Year 2 taxable year for purposes of Sec. 1.59A-4(b)(2)(i).
(B) Ordering rules for disallowed business interest expense
carryforward. The disallowed business interest expense carryforward
of $20x from Year 2 is correspondingly treated first as business
interest expense paid to Bank under paragraph (c)(4)(i) of this
section. The disallowed business interest expense carryforward of
$480x from the Year 1 layer that is also not allowed as a deduction
in Year 2 remains treated as $420x paid to Bank and $60 paid to FP.
(5) Example 5: Interaction with section 163(j); carryforward--
(i) Facts. The facts are the same as in paragraph (d)(4) of this
section (the facts in Example 4), except that in addition, in Year
3, DC has adjusted taxable income of $4000x and pays no business
interest expense. DC does not earn any business interest income or
incur any floor plan financing interest expense in Year 3.
(ii) Analysis. In Year 3, DC is treated as having paid or
accrued total business interest expense of $500x, consisting of
$480x of business interest expense that is carried forward from Year
1 and $20x of business interest expense that is carried forward from
Year 2 for purposes of section 163(j)(1). DC is permitted to deduct
$1200x of business interest expense in Year 3 under the limitation
in section 163(j)(1) ($4000x x 30%). For purposes of section 163(j),
DC is treated as first deducting the business interest expense from
Year 1 then the business interest expense from Year 2. See Sec.
1.163(j)-5(b)(2). Because none of DC's $500x business interest
expense is limited under section 163(j), the stacking rule in
paragraph (c)(4)(ii) of this section for allowed and disallowed
business interest expense does not apply. For purposes of Sec.
1.59A-4(b)(2)(i), DC's add-back to modified taxable income is $60x
determined by the classifications in paragraph (c)(4)(i)(A) of this
section ($60x treated as paid to FP from Year 1).
(6) Example 6: Interaction with section 163(j); partnership--(i)
Facts. The facts are the same as in paragraph (d)(4) of this section
(the facts in Example 4), except that in addition, in Year 2, DC
forms a domestic partnership (PRS) with Y, a domestic corporation
that is not related to DC within the meaning of Sec. 1.59A-
1(b)(17). PRS does not conduct a utility trade or business as
described in section 163(j)(7)(A)(iv), an electing real property
trade or business as described in section 163(j)(7)(B) or an
electing farming business as described in section 163(j)(7)(C)
subject to section 163(j). PRS is not a small business described in
section 163(j)(3). DC and Y are equal partners in partnership PRS.
In Year 2, PRS has ATI of $100x and $48x of business interest
expense. $12x of PRS's business interest expense is paid to Bank,
and $36x of PRS's business interest expense is paid to FP. PRS
allocates the items comprising its $100x of ATI $50x to DC and $50x
to Y. PRS allocates its $48x of business interest expense $24x to DC
and $24x to Y. DC classifies its $24x of business interest expense
as $6x unrelated business interest expense (Bank) and $18x as
foreign related business interest expense (FP) under paragraph
(c)(4)(i)(B) of this section. Y classifies its $24x of business
interest expense as entirely unrelated business interest expense of
Y (Bank and FP) under paragraph (c)(4)(i)(B) of this section. None
of the exceptions in paragraph (b)(3) of this section apply.
(ii) Partnership level analysis. In Year 2, PRS's section 163(j)
limit is 30 percent of its ATI, or $30x ($100x x 30 percent). Thus,
PRS has $30x of deductible business interest expense and $18x of
excess business interest expense ($48x-$30x). The $30x of deductible
business interest expense is includible in PRS's non-separately
stated income or loss, and is not subject to further limitation
under section 163(j) at the partners' level.
(iii) Partner level allocations analysis. Pursuant to Sec.
1.163(j)-6(f)(2), DC and Y are each allocated $15x of deductible
business interest expense and $9x of excess business interest
expense. At the end of Year 2, DC and Y each have $9x of excess
business interest expense from PRS, which under Sec. 1.163(j)-6 is
not treated as paid or accrued by the partner until such partner is
allocated excess taxable income or excess business interest income
from PRS in a succeeding year. Pursuant to Sec. 1.163(j)-6(e), DC
and Y, in computing their limit under section 163(j), do not
increase any of their section 163(j) items by any of PRS's section
163(j) items.
(iv) Partner level allocations for determining base erosion tax
benefits. The $15x of deductible business interest expense allocated
to DC is treated first as foreign related business interest expense
(FP) under paragraph (c)(4)(ii)(B) of this section. DC's excess
business interest expense from PRS of $9x is classified first as the
unrelated business interest expense with respect to Bank ($6x) and
then as the remaining portion of the business interest expense paid
to FP ($3x, or $18x-$15x). Under paragraph (c)(4)(ii)(B)(3) of this
section, these classifications of the PRS items apply irrespective
of the classifications of DC's own interest expense as set forth in
paragraph (d)(4) of this section (Example 4).
(v) Computation of modified taxable income. For Year 2, DC is
treated as having incurred base erosion tax benefits of $60x,
consisting of the $15x base erosion tax benefit with respect to its
interest in PRS that is computed in paragraph (d)(6)(iii) of this
section (Example 6) and $45x that is computed in paragraph (d)(4) of
this section (Example 4).
(7) Example 7: Transfers of property to related taxpayers--(i)
Facts. FP is a foreign corporation that owns all of the stock of DC1
and DC2, both domestic corporations. DC1 and DC2 are both members of
the same aggregate group but are not members of the same
consolidated tax group under section 1502. In Year 1, FP sells
depreciable property to DC1. On the first day of the Year 2 tax
year, DC1 sells the depreciable property to DC2.
(ii) Analysis--(A) Year 1. The acquisition of depreciable
property by DC1 from FP is a base erosion payment under paragraph
[[Page 67030]]
(b)(1)(ii) of this section because there is a payment to a foreign
related party in connection with the acquisition by the taxpayer of
property of a character subject to the allowance for depreciation.
(B) Year 2. The acquisition of the depreciable property in Year
2 by DC2 is not itself a base erosion payment because DC2 did not
acquire the property from a foreign related party. However, under
paragraph (b)(2)(viii) of this section any depreciation expense
taken by DC2 on the property acquired from DC1 is a base erosion
payment and a base erosion tax benefit under paragraph (c)(1)(ii) of
this section because the acquisition of the depreciable property was
a base erosion payment by DC1 and the property was sold to a member
of the aggregate group; therefore, the depreciation expense
continues as a base erosion tax benefit to DC2 as it would have been
to DC1 if it continued to own the property.
Sec. 1.59A-4 Modified taxable income.
(a) Scope. Paragraph (b)(1) of this section provides rules for
computing modified taxable income. Paragraph (b)(2) of this section
provides rules addressing how base erosion tax benefits and net
operating losses affect modified taxable income. Paragraph (b)(3) of
this section provides a rule for a holder of a residual interest in a
REMIC. Paragraph (c) of this section provides examples illustrating the
rules described in this section.
(b) Computation of modified taxable income--(1) In general. The
term modified taxable income means a taxpayer's taxable income, as
defined in section 63(a), determined with the additions described in
paragraph (b)(2) of this section. Notwithstanding the foregoing, the
taxpayer's taxable income may not be reduced to an amount less than
zero as a result of a net operating loss deduction allowed under
section 172. See paragraphs (c)(1) and (2) of this section (Examples 1
and 2).
(2) Modifications to taxable income. The amounts described in this
paragraph (b)(2) are added back to a taxpayer's taxable income to
determine its modified taxable income.
(i) Base erosion tax benefits. The amount of any base erosion tax
benefit as defined in Sec. 1.59A-3(c)(1).
(ii) Certain net operating loss deductions. The base erosion
percentage, as described in Sec. 1.59A-2(e)(3), of any net operating
loss deduction allowed to the taxpayer under section 172 for the
taxable year. For purposes of determining modified taxable income, the
net operating loss deduction allowed does not exceed taxable income
before taking into account the net operating loss deduction. See
paragraph (c)(1) and (2) of this section (Examples 1 and 2). The base
erosion percentage for the taxable year that the net operating loss
arose is used to determine the addition under this paragraph
(b)(2)(ii). For a net operating loss that arose in a taxable year
beginning before January 1, 2018, the base erosion percentage for the
taxable year is zero.
(3) Rule for holders of a residual interest in a REMIC. For
purposes of paragraph (b)(1) of this section, the limitation in section
860E(a)(1) is not taken into account in determining the taxable income
amount that is used to compute modified taxable income for the taxable
year.
(c) Examples. The following examples illustrate the rules of
paragraph (b) of this section.
(1) Example 1: Current year loss--(i) Facts. A domestic
corporation (DC) is an applicable taxpayer that has a calendar
taxable year. In 2020, DC has gross income of $100x, a deduction of
$80x that is not a base erosion tax benefit, and a deduction of $70x
that is a base erosion tax benefit. In addition, DC has a net
operating loss carryforward to 2020 of $400x that arose in 2016.
(ii) Analysis. DC's starting point for computing modified
taxable income is $(50x), computed as gross income of $100x, less a
deduction of $80x (non-base erosion tax benefit) and a deduction of
$70x (base erosion tax benefit). Under paragraph (b)(2)(ii) of this
section, DC's starting point for computing modified taxable income
does not take into account the $400x net operating loss carryforward
because the allowable deductions for 2020, not counting the NOL
deduction, exceed the gross income for 2020. DC's modified taxable
income for 2020 is $20x, computed as $(50x) + $70x base erosion tax
benefit.
(2) Example 2: Net operating loss deduction--(i) Facts. The
facts are the same as in paragraph (c)(1)(i) of this section (the
facts in Example 1), except that DC's gross income in 2020 is $500x.
(ii) Analysis. DC's starting point for computing modified
taxable income is $0x, computed as gross income of $500x, less: A
deduction of $80x (non-base erosion tax benefit), a deduction of
$70x (base erosion tax benefit), and a net operating loss deduction
of $350x (which is the amount of taxable income before taking into
account the net operating loss deduction, as provided in paragraph
(b)(2)(ii) of this section ($500x-$150x)). DC's modified taxable
income for 2020 is $70x, computed as $0x + $70x base erosion tax
benefit. DC's modified taxable income is not increased as a result
of the $350x net operating loss deduction in 2020 because the base
erosion percentage of the net operating loss that arose in 2016 is
zero under paragraph (b)(2)(ii) of this section.
Sec. 1.59A-5 Base erosion minimum tax amount.
(a) Scope. Paragraph (b) of this section provides rules regarding
the calculation of the base erosion minimum tax amount. Paragraph (c)
of this section describes the base erosion and anti-abuse tax rate
applicable to the taxable year.
(b) Base erosion minimum tax amount--(1) In general. For each
taxable year, an applicable taxpayer must determine its base erosion
minimum tax amount.
(2) Calculation of base erosion minimum tax amount. With respect to
any applicable taxpayer, the base erosion minimum tax amount for any
taxable year is, the excess (if any) of--
(i) An amount equal to the base erosion and anti-abuse tax rate
multiplied by the modified taxable income of the taxpayer for the
taxable year, over
(ii) An amount equal to the regular tax liability as defined in
Sec. 1.59A-1(b)(16) of the taxpayer for the taxable year, reduced (but
not below zero) by the excess (if any) of--
(A) The credits allowed under chapter 1 of subtitle A of the Code
against regular tax liability over
(B) The sum of the credits described in paragraph (b)(3) of this
section.
(3) Credits that do not reduce regular tax liability. The sum of
the following credits are used in paragraph (b)(2)(ii)(B) of this
section to limit the amount by which the credits allowed under chapter
1 of subtitle A of the Internal Revenue Code reduce regular tax
liability--
(i) Taxable years beginning on or before December 31, 2025. For any
taxable year beginning on or before December 31, 2025--
(A) The credit allowed under section 38 for the taxable year that
is properly allocable to the research credit determined under section
41(a);
(B) The portion of the applicable section 38 credits not in excess
of 80 percent of the lesser of the amount of those applicable section
38 credits or the base erosion minimum tax amount (determined without
regard to this paragraph (b)(3)(i)(B)); and
(C) Any credits allowed under sections 33, 37, and 53.
(ii) Taxable years beginning after December 31, 2025. For any
taxable year beginning after December 31, 2025, any credits allowed
under sections 33, 37, and 53.
(c) Base erosion and anti-abuse tax rate--(1) In general. For
purposes of calculating the base erosion minimum tax amount, the base
erosion and anti-abuse tax rate is--
(i) Calendar year 2018. For taxable years beginning in calendar
year 2018, five percent.
(ii) Calendar years 2019 through 2025. For taxable years beginning
after December 31, 2018, through taxable
[[Page 67031]]
years beginning before January 1, 2026, 10 percent.
(iii) Calendar years after 2025. For taxable years beginning after
December 31, 2025, 12.5 percent.
(2) Increased rate for banks and registered securities dealers--(i)
In general. In the case of a taxpayer that is a member of an affiliated
group (as defined in section 1504(a)(1)) that includes a bank or a
registered securities dealer, the percentage otherwise in effect under
paragraph (c)(1) of this section is increased by one percentage point.
(ii) De minimis exception to increased rate for banks and
registered securities dealers. Paragraph (c)(2)(i) of this section does
not apply to a taxpayer that is a member of an affiliated group (as
defined in section 1504(a)(1)) that includes a bank or registered
securities dealer if, in that taxable year, the total gross receipts of
the affiliated group attributable to the bank or the registered
securities dealer (or attributable to all of the banks and registered
securities dealers in the group, if more than one) represent less than
two percent of the total gross receipts of the affiliated group, as
determined under Sec. 1.59A-2(d).
(3) Application of section 15 to tax rates in section 59A--(i) New
tax. Section 15 does not apply to any taxable year that includes
January 1, 2018.
(ii) Change in tax rate pursuant to section 59A(b)(1)(A). Section
15 does not apply to any taxable year that includes January 1, 2019.
(iii) Change in rate pursuant to section 59A(b)(2). Section 15
applies to the change in tax rate pursuant to section 59A(b)(2)(A).
Sec. 1.59A-6 Qualified derivative payment.
(a) Scope. This section provides additional guidance regarding
qualified derivative payments. Paragraph (b) of this section defines
the term qualified derivative payment. Paragraph (c) of this section
provides guidance on certain payments that are not treated as qualified
derivative payments. Paragraph (d) defines the term derivative for
purposes of section 59A. Paragraph (e) of this section provides
examples illustrating the rules of this section.
(b) Qualified derivative payment--(1) In general. A qualified
derivative payment means any payment made by a taxpayer to a foreign
related party pursuant to a derivative with respect to which the
taxpayer--
(i) Recognizes gain or loss as if the derivative were sold for its
fair market value on the last business day of the taxable year (and any
additional times as required by the Internal Revenue Code or the
taxpayer's method of accounting);
(ii) Treats any gain or loss so recognized as ordinary; and
(iii) Treats the character of all items of income, deduction, gain,
or loss with respect to a payment pursuant to the derivative as
ordinary.
(2) Reporting requirements--(i) In general. No payment is a
qualified derivative payment under paragraph (b)(1) of this section for
any taxable year unless the taxpayer (whether or not the taxpayer is a
reporting corporation as defined in Sec. 1.6038A-1(c)) reports the
information required in Sec. 1.6038A-2(b)(7)(ix) for the taxable year.
To report its qualified derivative payments, a taxpayer must include
the payment in the aggregate amount of qualified derivative payments on
Form 8991 (or successor).
(ii) Failure to satisfy the reporting requirement. If a taxpayer
fails to satisfy the reporting requirement described in paragraph
(b)(2)(i) of this section with respect to any payments, those payments
are not eligible for the qualified derivative payment exception
described in Sec. 1.59A-3(b)(3)(ii) and are base erosion payments
unless an exception in Sec. 1.59A-3(b)(3) otherwise applies. A
taxpayer's failure to report a payment as a qualified derivative
payment does not impact the eligibility of any other payment which the
taxpayer properly reported under paragraph (b)(2)(i) of this section
from being a qualified derivative payment.
(iii) Reporting of aggregate amount of qualified derivative
payments. The aggregate amount of qualified derivative payments is the
sum of the amount described in paragraph (b)(3) of this section for
each derivative. To the extent that the taxpayer is treated as
receiving a payment, as determined in Sec. 1.59A-2(e)(3)(vi), for the
taxable year with respect to a derivative, the payment is not included
in the aggregate qualified derivative payments.
(iv) Transition period for qualified derivative payment reporting.
Before paragraph (b)(2)(i) of this section is applicable, a taxpayer
will be treated as satisfying the reporting requirement described
section 59A(h)(2)(B) to the extent that the taxpayer reports the
aggregate amount of qualified derivative payments on Form 8991 (or
successor). See Sec. 1.6038A-2(g) (applicability date for Sec.
1.6038A-2(b)(7)(ix)). Until paragraph (b)(2)(i) of this section is
applicable, paragraph (b)(2)(ii) of this section will not apply to a
taxpayer who reports the aggregate amount of qualified derivative
payments in good faith.
(3) Amount of any qualified derivative payment--(i) In general. The
amount of any qualified derivative payment excluded from the
denominator of the base erosion percentage as provided in Sec. 1.59A-
2(e)(3)(ii)(C) is determined as provided in Sec. 1.59A-2(e)(3)(vi).
(ii) Net qualified derivative payment that includes a payment that
is a base erosion payment. Any net amount determined in paragraph
(b)(3)(i) of this section must be reduced by any gross items that are
treated as a base erosion payment pursuant to paragraph (c) of this
section.
(c) Exceptions for payments otherwise treated as base erosion
payments. A payment does not constitute a qualified derivative payment
if--
(1) The payment would be treated as a base erosion payment if it
were not made pursuant to a derivative, including any interest,
royalty, or service payment; or
(2) In the case of a contract that has derivative and nonderivative
components, the payment is properly allocable to the nonderivative
component.
(d) Derivative defined--(1) In general. For purposes of this
section, the term derivative means any contract (including any option,
forward contract, futures contract, short position, swap, or similar
contract) the value of which, or any payment or other transfer with
respect to which, is (directly or indirectly) determined by reference
to one or more of the following:
(i) Any share of stock in a corporation;
(ii) Any evidence of indebtedness;
(iii) Any commodity that is actively traded;
(iv) Any currency; or
(v) Any rate, price, amount, index, formula, or algorithm.
(2) Exceptions. The following contracts are not treated as
derivatives for purposes of section 59A.
(i) Direct interest. A derivative contract does not include a
direct interest in any item described in paragraph (d)(1)(i) through
(v) of this section.
(ii) Insurance contracts. A derivative contract does not include
any insurance, annuity, or endowment contract issued by an insurance
company to which subchapter L applies (or issued by any foreign
corporation to which the subchapter would apply if the foreign
corporation were a domestic corporation).
(iii) Securities lending and sale-repurchase transactions--(A)
Multi-step transactions treated as financing. For purposes of paragraph
(d)(1) of this section, a derivative does not include any securities
lending transaction, sale-
[[Page 67032]]
repurchase transaction, or substantially similar transaction that is
treated as a secured loan for federal tax purposes. Securities lending
transaction and sale-repurchase transaction have the meanings provided
in Sec. 1.861-2(a)(7).
(B) Special rule for payments associated with the cash collateral
provided in a securities lending transaction or substantially similar
transaction. For purposes of paragraph (d)(1) of this section, a
derivative does not include the cash collateral component of a
securities lending transaction (or the cash payments pursuant to a
sale-repurchase transaction, or similar payments pursuant to a
substantially similar transaction).
(C) Anti-abuse exception for certain transactions that are the
economic equivalent of substantially unsecured cash borrowing. For
purposes of paragraph (d)(1) of this section, a derivative does not
include any securities lending transaction or substantially similar
transaction that is part of an arrangement that has been entered into
with a principal purpose of avoiding the treatment of any payment with
respect to that transaction as a base erosion payment and that provides
the taxpayer with the economic equivalent of a substantially unsecured
cash borrowing. The determination of whether the securities lending
transaction or substantially similar transaction provides the taxpayer
with the economic equivalent of a substantially unsecured cash
borrowing takes into account arrangements that effectively serve as
collateral due to the taxpayer's compliance with any U.S. regulatory
requirements governing such transaction.
(3) American depository receipts. For purposes of section 59A,
American depository receipts (or any similar instruments) with respect
to shares of stock in a foreign corporation are treated as shares of
stock in that foreign corporation.
(e) Examples. The following examples illustrate the rules of this
section.
(1) Example 1: Notional principal contract as QDP--(i) Facts.
Domestic Corporation (DC) is a dealer in securities within the
meaning of section 475. On February 1, 2019, DC enters into a
contract (Interest Rate Swap) with Foreign Parent (FP), a foreign
related party, for a term of five years. Under the Interest Rate
Swap, DC is obligated to make a payment to FP each month, beginning
March 1, 2019, in an amount equal to a variable rate determined by
reference to the prime rate, as determined on the first business day
of the immediately preceding month, multiplied by a notional
principal amount of $50x. Under the Interest Rate Swap, FP is
obligated to make a payment to DC each month, beginning March 1,
2019, in an amount equal to 5% multiplied by the same notional
principal amount. The Interest Rate Swap satisfies the definition of
a notional principal contract under Sec. 1.446-3(c). DC recognizes
gain or loss on the Interest Rate Swap pursuant to section 475. DC
reports the information required to be reported for the taxable year
under Sec. 1.6038A-2(b)(7)(ix).
(ii) Analysis. The Interest Rate Swap is a derivative as
described in paragraph (d) of this section because it is a contract
that references the prime rate and a fixed rate for determining the
amount of payments. The exceptions described in paragraph (c) of
this section do not apply to the Interest Rate Swap. Because DC
recognizes ordinary gain or loss on the Interest Rate Swap pursuant
to section 475(d)(3), it satisfies the condition in paragraph
(b)(1)(ii) of this section. Because DC satisfies the requirement
relating to the information required to be reported under paragraph
(b)(2) of this section, any payment to FP with respect to the
Interest Rate Swap will be a qualified derivative payment.
Therefore, under Sec. 1.59A-3(b)(3)(ii), the payments to FP are not
base erosion payments.
(2) Example 2: Securities lending anti-abuse rule--(i) Facts.
(A) Foreign Parent (FP) is a foreign corporation that owns all of
the stock of domestic corporation (DC) and foreign corporation (FC).
FP and FC are foreign related parties of DC under Sec. 1.59A-
1(b)(12) but not members of DC's aggregate group. On January 1 of
year 1, with a principal purpose of providing financing to DC
without DC making a base erosion payment to FC, FC lends 100x U.S.
Treasury bills with a remaining maturity of 11 months (Securities A)
to DC (Securities Lending Transaction 1) for a period of six months.
Pursuant to the terms of Securities Lending Transaction 1, DC is
obligated to make substitute payments to FC corresponding to the
interest payments on Securities A. DC does not post cash collateral
with respect to Securities Lending Transaction 1, and no other
arrangements of FC or DC effectively serve as collateral under any
U.S. regulatory requirements governing the transaction. Immediately
thereafter, DC sells Securities A for cash.
(B) On June 30 of year 1, FC lends 100x U.S. Treasury bills with
a remaining maturity of 11 months (Securities B) to DC (Securities
Lending Transaction 2) for a period of six months. Pursuant to the
terms of Securities Lending Transaction 2, DC is obligated to make
substitute payments to FC corresponding to the interest payments on
Securities B. Immediately thereafter, DC sells Securities B for cash
and uses the cash to purchase U.S. Treasury bills with a remaining
maturity equal to the Securities A bills that DC then transfers to
FC in repayment of Securities Lending Transaction 1.
(ii) Analysis. Securities Lending Transaction 1 and Securities
Lending Transaction 2 are not treated as derivatives for purposes of
paragraph (d)(1) of this section because the transactions are part
of an arrangement that has been entered into with a principal
purpose of avoiding the treatment of any payment with respect to
Securities Lending Transaction 1 and Securities Lending Transaction
2 as a base erosion payment and provides DC with the economic
equivalent of a substantially unsecured cash borrowing by DC. As a
result, pursuant to paragraph (d)(2)(iii)(C) of this section, the
substitute payments made by DC to FC with respect to Securities A
and Securities B are not eligible for the exception in Sec. 1.59A-
3(b)(3)(ii) (qualified derivative payment).
Sec. 1.59A-7 Application of base erosion and anti-abuse tax to
partnerships.
(a) Scope. This section provides rules regarding how partnerships
and their partners are treated for purposes of making certain
determinations under section 59A, including whether there is a base
erosion payment or base erosion tax benefit. All references to
partnerships in this section include domestic and foreign partnerships.
This section applies to payments to a partnership and payments from a
partnership as well as transfers of partnership interests (as defined
in paragraph (c)(3)(iv) of this section). The aggregate principle
described in this section does not override the treatment of
partnership items under any Code section other than section 59A. The
aggregate principles provided in this section apply without regard to
any tax avoidance purpose relating to a particular partnership. See
Sec. 1.701-2(e). Paragraph (b) of this section describes how the
aggregate approach to partnerships applies for purposes of certain
section 59A determinations. Paragraph (c) of this section provides
rules for determining whether there is a base erosion payment with
respect to a payment to or from a partnership. Paragraph (d) of this
section provides rules for determining the base erosion tax benefits of
a partner. Paragraph (e) of this section provides additional rules
relating to the application of section 59A to partnerships. Paragraph
(f) of this section provides a rule for determining whether a person is
a foreign related party. Paragraph (g) of this section provides
examples that illustrate the application of the rules of this section.
(b) Application of section 59A to partnerships. The purpose of this
section is to provide a set of operating rules for the application of
section 59A to partnerships and partners in a manner consistent with
the purposes of section 59A. Except for purposes of determining a
partner's base erosion tax benefits under paragraph (d)(1) of this
section and whether a taxpayer is a registered securities dealer under
paragraph (e)(3) of this section, section 59A determinations are made
at the
[[Page 67033]]
partner level in the manner described in this section. The provisions
of section 59A must be interpreted in a manner consistent with this
approach. If a transaction is not specifically described in this
section, whether the transaction gives rise to a base erosion payment
or base erosion tax benefit is determined in accordance with the
principles of this section and the purposes of section 59A.
(c) Base erosion payment. For purposes of determining whether a
taxpayer has made a base erosion payment as described in Sec. 1.59A-
3(b), the taxpayer must treat a payment to or from a partnership as
made to or from each partner and the assets and liabilities of the
partnership as assets and liabilities of each partner. This paragraph
(c) provides specific rules for determining whether a partner has made
or received a payment, including as a result of a partnership interest
transfer (as defined in paragraph (c)(3)(iv) of this section).
(1) Payments made by or to a partnership. For purposes of
determining whether a payment or accrual by a partnership is a base
erosion payment described in Sec. 1.59A-3(b)(1)(i), any amount paid or
accrued by the partnership (including any guaranteed payment described
in section 707(c)) is treated as paid or accrued by each partner based
on the partner's distributive share of the item of deduction with
respect to that amount. For purposes of determining whether a payment
or accrual to a partnership is a base erosion payment described in
Sec. 1.59A-3(b)(1)(i) or (iii), any amount paid or accrued to the
partnership (including any guaranteed payment described in section
707(c)) is treated as paid or accrued to each partner based on the
partner's distributive share of the item of income with respect to that
amount. See paragraph (e)(1) of this section to determine the partner's
distributive share.
(2) Transfers of certain property. When a partnership transfers
property, each partner is treated as transferring its proportionate
share of the property transferred for purposes of determining whether
there is a base erosion payment described in Sec. 1.59A-3(b)(1)(ii) or
(iv). When a partnership acquires property, each partner is treated as
acquiring its proportionate share of the property acquired for purposes
of determining whether there is a base erosion payment described in
Sec. 1.59A-3(b)(1)(ii) or (iv). For purposes of this paragraph (c)(2),
a transfer of property does not include a transfer of a partnership
interest (as defined in paragraph (c)(3)(iv) of this section). See
paragraph (c)(3) of this section for rules applicable to transfers of
partnership interests. See paragraphs (g)(2)(v) and (vi) of this
section (Example 5 and Example 6) for examples illustrating the
application of this paragraph (c)(2).
(3) Transfers of a partnership interest--(i) In general. A transfer
of a partnership interest (as defined in paragraph (c)(3)(iv) of this
section) is generally treated as a transfer by each partner in the
partnership of its proportionate share of the partnership's assets to
the extent of any change in its proportionate share of any partnership
asset, as well as any assumption of associated liabilities by the
partner. Paragraphs (c)(3)(ii) and (iii) of this section provide rules
for applying the general rule to transfers of a partnership interest by
a partner and issuances of a partnership interest by the partnership
for contributed property, respectively. See paragraph (g)(2)(vii) of
this section (Example 7) for an example illustrating the application of
this paragraph (c)(3)(i).
(ii) Transfers of a partnership interest by a partner. A transfer
of a partnership interest (as defined in paragraph (c)(3)(iv) of this
section) by a partner is treated as a transfer by the transferor to the
recipient of the transferor's proportionate share of each of the
partnership assets and an assumption by the recipient of the
transferor's proportionate share of the partnership liabilities. If the
partner's entire partnership interest is not transferred, only the
proportionate share of each of the partnership assets and liabilities
associated with the transferred partnership interest is treated as
transferred and assumed. See paragraphs (g)(2)(iii), (iv), and (vi) of
this section (Example 3, Example 4, and Example 6) for examples
illustrating the application of this paragraph (c)(3)(ii).
(iii) Certain issuances of a partnership interest by a partnership.
If a partnership issues an interest in the partnership in exchange for
a contribution of property to the partnership, the contributing partner
is treated as exchanging a portion of the contributed property and
assuming any liabilities associated with the transferred partnership
interest for a portion of the partners' pre-contribution interests in
the partnership's assets and the partners' assumption of any
liabilities transferred to the partnership. For purposes of this
paragraph (c)(3)(iii), a reference to the ``partnership's assets''
includes the assets contributed by the contributing partner and any
other assets that are contributed to the partnership at the same time.
Each partner whose proportionate share in a partnership asset
(including the assets contributed to the partnership as part of the
transaction) is reduced as a result of the transaction is treated as
transferring the asset to the extent of the reduction, and each person
who receives a proportionate share or an increased proportionate share
in an asset as a result of the transaction is treated as receiving an
asset to the extent of the increase, proportionately from the partners'
reduced interests. For example, if a person contributes property to a
partnership in which each of two existing partners has a 50 percent
pro-rata interest in the partnership in exchange for a one-third pro-
rata partnership interest, each of the pre-contribution partners is
treated as transferring a one-third interest in their share of existing
partnership assets to the contributing partner, and the contributing
partner is treated as transferring a one-third interest in the
contributed assets to each of the original partners. See paragraphs
(g)(2)(i) and (ii) of this section (Example 1 and Example 2) for
additional examples illustrating the application of this paragraph
(c)(3)(iii).
(iv) Partnership interest transfers defined. For purposes of
paragraphs (c)(3) and (4) of this section, a transfer of a partnership
interest includes any issuance of a partnership interest by a
partnership; any sale of a partnership interest; any increase or
decrease in a partner's proportionate share of any partnership asset as
a result of a contribution of property or services to a partnership, a
distribution, or a redemption; or any other transfer of a proportionate
share of any partnership asset (other than a transfer of a partnership
asset that is not a partnership interest by the partnership to a person
not acting in a partner capacity), whether by a partner or the
partnership (including as a result of a deemed or actual sale or a
capital shift).
(4) Increased basis from a distribution. If a distribution of
property from a partnership to a partner results in an increase in the
tax basis of either the distributed property or other partnership
property, such as under section 732(b) or 734(b), the increase in tax
basis attributable to a foreign related party is treated as if it was
newly purchased property acquired by the taxpayer (to the extent of its
proportionate share) from the foreign related party that is placed in
service when the distribution occurs. See Sec. 1.734-1(e). This
increased basis treated as newly purchased property is treated as
acquired with a base erosion payment, unless an exception in Sec.
1.59A-3(b) applies. For this purpose,
[[Page 67034]]
in the case of a distribution to a foreign related party, the increased
basis in the remaining partnership property that is treated as newly
purchased property is entirely attributable to the foreign related
party. In the case of a distribution to a taxpayer, the increased basis
in the distributed property that is treated as newly purchased property
is attributable to each foreign related party in proportion to the
foreign related party's proportionate share of the asset immediately
before the distribution. If the distribution is to a person other than
a taxpayer or a foreign related party, there is no base erosion payment
caused by the distribution under this paragraph (c)(4). See paragraphs
(g)(2)(vii), (viii), and (ix) of this section (Example 7, Example 8,
and Example 9) for examples illustrating the application of this
paragraph (c)(4).
(5) Operating rules applicable to base erosion payments--(i) Single
payment characterized as separate transactions. If a single transaction
is partially characterized in one manner and partially characterized in
another manner, each part of the transaction is separately analyzed.
For example, if a contribution of property to a partnership is
partially treated as a contribution and partially treated as a
disguised sale, the contribution and sale are separately analyzed under
paragraph (c) of this section.
(ii) Ordering rule with respect to transfers of a partnership
interest. If a partnership interest is transferred (within the meaning
of paragraph (c)(3)(iv) of this section), paragraph (c)(3) of this
section first applies to determine the assets deemed transferred by the
transferor(s) to the transferee(s) and liabilities deemed assumed by
the parties. Then, to the extent applicable (such as where a
partnership makes a contribution in exchange for an interest in another
partnership or when a partnership receives an interest in another
partnership as a contribution to it), paragraph (c)(2) of this section
applies for purposes of determining the proportionate share of the
property received by the partners in a partnership. See paragraph
(g)(2)(vi) of this section (Example 6) for an illustration of this
rule.
(iii) Consideration for base erosion payment or property resulting
in base erosion tax benefits. When a partnership pays or receives
property, services, or other consideration, each partner is deemed to
pay or receive the property, services, or other consideration paid or
received by the partnership for purposes of determining if there is a
base erosion payment, except as otherwise provided in paragraph (c) of
this section. See paragraphs (g)(2)(v) and (vi) of this section
(Example 5 and Example 6) for illustrations of this rule.
(iv) Non-cash consideration. When both parties to a transaction use
non-cash consideration, each party must separately apply paragraph (c)
of this section to determine its base erosion payment with respect to
each property. For example, if two partnerships, each with a domestic
corporation and a foreign corporation as partners, all of whom are
related, exchange depreciable property, each transfer of property would
be separately analyzed to determine whether it is a base erosion
payment.
(d) Base erosion tax benefit for partners--(1) In general. A
partner's distributive share of any deduction or reduction in gross
receipts attributable to a base erosion payment (including as a result
of sections 704(b) and (c), 707(a) and (c), 732(b) and (d), 734(b) and
(d), 737, 743(b) and (d), and 751(b)) is the partner's base erosion tax
benefit, subject to the exceptions in Sec. 1.59A-3(c)(2). See
paragraph (e)(1) of this section to determine the partner's
distributive share for purposes of section 59A. A partner's base
erosion tax benefit may be more than the partner's base erosion
payment. For example, if a partnership makes a payment to a foreign
related party of its domestic partner to acquire a depreciable asset,
and the partnership specially allocates more depreciation deductions to
a partner than its proportionate share of the asset, the partner's base
erosion tax benefit includes the specially allocated depreciation
deduction even if the total allocated deduction exceeds the partner's
share of the base erosion payment made to acquire the asset. Base
erosion tax benefits are determined separately for each asset, payment,
or accrual, as applicable, and are not netted with other items. A
taxpayer determines its base erosion tax benefits for non-partnership
items pursuant to Sec. 1.59A-3(c).
(2) Exception for base erosion tax benefits of certain small
partners--(i) In general. For purposes of determining a partner's
amount of base erosion tax benefits attributable to a base erosion
payment made by a partnership, a partner does not take into account its
distributive share of any base erosion tax benefits from the
partnership for the taxable year if--
(A) The partner's interest in the partnership represents less than
ten percent of the capital and profits of the partnership at all times
during the taxable year;
(B) The partner is allocated less than ten percent of each
partnership item of income, gain, loss, deduction, and credit for the
taxable year; and
(C) The partner's interest in the partnership has a fair market
value of less than $25 million on the last day of the partner's taxable
year, determined using a reasonable method.
(ii) Attribution. For purposes of paragraph (d)(2)(i) of this
section, a partner's interest in a partnership or partnership item is
determined by adding the interests of the partner and any related party
of the partner (as determined under section 59A), taking into account
any interest owned directly, indirectly, or through constructive
ownership (applying the section 318 rules as modified by section 59A
(except section 318(a)(3)(A) through (C) will also apply so as to
consider a United States person as owning stock that is owned by a
person who is not a United States person), but excluding any interest
to the extent already taken into account).
(e) Other rules for applying section 59A to partnerships--(1)
Partner's distributive share. For purposes of section 59A, each
partner's distributive share of an item of income or deduction of the
partnership is determined under sections 704(b) and (c) and takes into
account amounts determined under other provisions of the Code,
including but not limited to sections 707(a) and (c), 732(b) and (d),
734(b) and (d), 737, 743(b) and (d), and 751(b). See Sec. 1.704-
1(b)(1)(iii) regarding the application of section 482. These amounts
are calculated separately for each payment or accrual on a property-by-
property basis, including for purposes of section 704(c), and are not
netted. For purposes of section 59A, a partner's distributive share of
a reduction to determine gross income is equal to a proportionate
amount of the partnership's reduction to determine gross income
corresponding to the partner's share of the partnership gross receipts
(as determined under paragraph (e)(2)(i) of this section) related to
that reduction.
(2) Gross receipts--(i) In general. For purposes of section 59A,
each partner in the partnership includes a share of partnership gross
receipts in proportion to the partner's distributive share (as
determined under sections 704(b) and (c)) of items of gross income that
were taken into account by the partnership under section 703 or 704(c)
(such as remedial or curative items under Sec. 1.704-3(c) or (d)).
(ii) Foreign corporation. See Sec. 1.59A-2(d)(2) for gross
receipts of foreign corporations.
[[Page 67035]]
(3) Registered securities dealers. If a partnership, or a branch of
the partnership, is a registered securities dealer, each partner is
treated as a registered securities dealer unless the partner's interest
in the registered securities dealer would satisfy the criteria for the
exception in paragraph (d)(2) of this section. For purposes of applying
the de minimis exception in Sec. 1.59A-2(e)(2)(iii), a partner takes
into account its distributive share of the relevant partnership items.
(4) Application of sections 163(j) and 59A(c)(3) to partners. See
Sec. 1.59A-3(c)(4).
(5) Tiered partnerships. In the case of one or more partnerships
owning an interest in another partnership (or partnerships), the rules
of this section apply successively to each partnership and its partners
in the chain of ownership. Paragraphs (d)(2) and (f) of this section
and the small partner exception in paragraph (e)(3) of this section
apply only to a partner that is not itself a partnership.
(f) Foreign related party. With respect to any person that owns an
interest in a partnership, the related party determination in section
59A(g) applies at the partner level.
(g) Examples. The following examples illustrate the application of
this section.
(1) Facts. The following facts are assumed for purposes of the
examples.
(i) DC is a domestic corporation that is an applicable taxpayer for
purposes section 59A.
(ii) FC is a foreign corporation that is a foreign related party
with respect to DC.
(iii) UC is a domestic corporation that is not related to DC and
FC.
(iv) Neither FC nor any partnership in the examples is (or is
treated as) engaged in a U.S. trade or business or has a permanent
establishment in the United States.
(v) All payments apply to a taxable year beginning after December
31, 2017.
(vi) Unless otherwise stated, all allocations are pro-rata and
satisfy the requirements of section 704(b) and all the partners have
equal interests in the partnership.
(vii) Unless otherwise stated, depreciable property acquired and
placed in service by the partnership has a remaining recovery period of
five years and is depreciated under the alternative depreciation system
of section 168(g) using the straight line method. Solely for purposes
of simplifying the calculations in these examples, assume the
applicable convention rules in section 168(d) do not apply.
(viii) No exception under Sec. 1.59A-3(b) or (c) applies to any
amount paid or accrued.
(2) Examples--(i) Example 1: Contributions to a partnership on
partnership formation--(A) Facts. DC and FC form partnership PRS, with
each contributing depreciable property that has a fair market value and
tax basis of $100x, Property A and Property B, respectively. Therefore,
the property contributed by FC, Property B, will generate $20x of
annual section 704(b) and tax depreciation deductions for five years.
The depreciation deductions will be allocated $10x to each of DC and FC
each year. Before the transactions, for purposes of section 59A, DC is
treated as owning a 100 percent interest in Property A and a zero
percent interest in Property B, and FC is treated as owning a 100
percent interest in Property B and a zero percent interest in Property
A. After the formation of PRS, for purposes of section 59A, DC and FC
are each treated as owning a 50 percent proportionate share of each of
Property A and Property B.
(B) Analysis. The treatment of contributions of property in
exchange for an interest in a partnership is described in paragraph
(c)(3)(iii) of this section. Under paragraph (c)(3)(iii) of this
section, DC is treated as exchanging a 50 percent interest in
Property A for a 50 percent proportionate share of Property B. Under
Sec. 1.59A-3(b)(1)(ii), the payment to acquire depreciable
property, Property B, from FC is a base erosion payment. The base
erosion tax benefit is the amount of depreciation allocated to DC
with respect to Property B ($10x per year) and is not netted with
any other partnership item pursuant to paragraph (d)(1) of this
section.
(ii) Example 2: Section 704(c) and remedial allocations--(A)
Facts. The facts are the same as in paragraph (g)(2)(i)(A) of this
section (the facts in Example 1), except that Property B has a tax
basis of $40x and PRS adopts the remedial method under Sec. 1.704-
3(d).
(B) Analysis. The analysis and results are the same as in
paragraph (g)(2)(i)(B) of this section (the analysis in Example 1),
except that annual tax depreciation is $8x ($40x/5) and annual
remedial tax deduction allocation to DC is $2x (with $2x of remedial
income to FC) for five years. Both the tax depreciation and the
remedial tax allocation to DC are base erosion tax benefits to DC
under paragraph (d)(1) of this section.
(iii) Example 3: Sale of a partnership interest without a
section 754 election--(A) Facts. UC and FC are equal partners in
partnership PRS, the only asset of which is Property A, a
depreciable property with a fair market value of $200x and a tax
basis of $120x. PRS does not have any section 704(c) assets. DC
purchases 50 percent of FC's interest in PRS for $50x. Prior to the
sale, for section 59A purposes, FC is treated as owning a 50 percent
proportionate share of Property A and DC is treated as owning no
interest in Property A. Following the sale, for section 59A
purposes, DC is treated as owning a 25 percent proportionate share
of Property A, all of which is treated as acquired from FC. The
partnership does not have an election under section 754 in effect.
Property A will generate $24x of annual tax and section 704(b)
depreciation deductions for five years. The depreciation deductions
will be allocated $12x to UC and $6x to both FC and DC each year.
(B) Analysis. The sale of a partnership interest by a partner is
analyzed under paragraph (c)(3)(ii) of this section. Under section
(c)(3)(ii) of this section, FC is treated as selling to DC 25
percent of Property A. Under Sec. 1.59A-3(b)(1)(ii), the payment to
acquire depreciable property is a base erosion payment. Under
paragraph (d)(1) of this section, the base erosion tax benefit is
the amount of depreciation allocated to DC with respect to the base
erosion payment, which would be the depreciation deductions
allocated to DC with respect to Property A. DC's annual $6x
depreciation deduction is its base erosion tax benefit with respect
to the base erosion payment.
(iv) Example 4: Sale of a partnership interest with section 754
election--(A) Facts. The facts are the same as in paragraph
(g)(2)(iii)(A) of this section (the facts in Example 3), except that
the partnership has an election under section 754 in effect. As a
result of the sale, there is a $20x positive adjustment to the tax
basis in Property A with respect to DC under section 743(b) (DC's
$50x basis in the PRS interest less DC's $30x share of PRS's tax
basis in Property A). The section 743(b) step-up in tax basis is
recovered over a depreciable recovery period of five years.
Therefore, DC will be allocated a total of $10x in annual
depreciation deductions for five years, comprised of $6x with
respect to DC's proportionate share of PRS's common tax basis in
Property A ($30x over 5 years) and $4x with respect to the section
743(b) adjustment ($20x over 5 years).
(B) Analysis. The analysis is the same as in paragraph
(g)(2)(iii)(B) of this section (the analysis in Example 3); however,
because section 743(b) increases the basis in Property A for DC by
$20x, DC is allocated additional depreciation deductions of $4x per
year as a result of the section 743(b) adjustment and has an annual
base erosion tax benefit of $10x ($6x plus $4x) for five years under
paragraph (d)(1) of this section.
(v) Example 5: Purchase of depreciable property from a
partnership--(A) Facts. The facts are the same as in paragraph
(d)(2)(iii)(A) of this section (the facts in Example 3), except that
instead of DC purchasing an interest in the partnership, DC
purchases Property A from the partnership for $200x.
(B) Analysis. DC must analyze whether the purchase of the
depreciable property from the partnership is a base erosion payment
under paragraph (c)(2) of this section. Under paragraph (c)(2) of
this section, DC is treated as acquiring FC's proportionate share of
Property A from FC. Because DC paid the partnership for the
partnership's interest in Property A, under paragraph (c)(5)(iii) of
this section, DC is treated as paying FC for FC's proportionate
share of Property A. Under
[[Page 67036]]
Sec. 1.59A-3(b)(1)(ii), the payment to FC to acquire depreciable
property is a base erosion payment. DC's base erosion tax benefit is
the amount of depreciation allocated to DC with respect to the base
erosion payment, which in this case is the amount of depreciation
deductions with respect to the property acquired with a base erosion
payment, or the depreciation deductions from FC's (but not UC's)
proportionate share of the asset. See Sec. 1.59A-7(d)(1).
(vi) Example 6: Sale of a partnership interest to a second
partnership--(A) Facts. FC, UC1, and UC2 are equal partners in
partnership PRS1. DC and UC3 are equal partners in partnership PRS2.
UC1, UC2, and UC3 are not related to DC or FC. PRS1's sole asset is
Property A, which is depreciable property with a fair market value
and tax basis of $300x. FC sells its entire interest in PRS1 to PRS2
for $100. For section 59A purposes, FC's proportionate share of
Property A prior to the sale is one-third. Following the sale, for
section 59A purposes, PRS2's proportionate share of Property A is
one-third and DC's proportionate share of Property A (through PRS2)
is one-sixth (50 percent of one-third).
(B) Analysis. Under paragraph (c)(5)(ii) of this section (the
ordering rule), FC's transfer of its interest in PRS1 is first
analyzed under paragraph (c)(3) of this section to determine how the
transfer of the partnership interest is treated. Then, paragraph
(c)(2) of this section applies to analyze how the acquisition of
property by PRS2 is treated. Under paragraph (c)(3)(ii) of this
section, FC is deemed to transfer its proportionate share of PRS1's
assets, which is one-third of Property A. Then, under paragraph
(c)(2) of this section, DC is treated as acquiring its proportionate
share of PRS2's proportionate share of Property A from FC, which is
one-sixth (50 percent of one-third). Under paragraph (c)(5)(iii) of
this section, DC is treated as paying for the property it is treated
as acquiring from FC. Therefore, DC's deemed payment to FC to
acquire depreciable property is a base erosion payment under Sec.
1.59A-3(b)(1)(ii). DC's base erosion tax benefit is equal to DC's
distributive share of depreciation deductions that PRS2 allocates to
DC attributable to Property A. See Sec. 1.59A-7(d)(1).
(vii) Example 7: Distribution of cash by a partnership to a
foreign related party--(A) Facts. DC, FC, and UC are equal partners
in a partnership, PRS, the assets of which consist of cash of $90x
and a depreciable asset (Property A) with a fair market value of
$180x and a tax basis of $60x. Each partner's interest in PRS has a
fair market value of $90x ($270x/3) and a tax basis of $50x. Assume
that all non-depreciable assets are capital assets, all depreciable
assets are nonresidential real property under section 168, and that
no depreciation has been claimed prior to the transaction below. PRS
has an election under section 754 in effect. PRS distributes the
$90x of cash to FC in complete liquidation of its interest,
resulting in gain to FC of $40x ($90x minus its tax basis in PRS of
$50x) under section 731(a)(1) and an increase to the tax basis of
Property A under section 734(b) of $40x. Prior to the distribution,
for section 59A purposes, each partner had a one-third proportionate
share of Property A. After the distribution, for section 59A
purposes, the remaining partners each have a 50 percent
proportionate share of Property A. Each partner's pro-rata
allocation of depreciation deductions with respect to Property A is
in proportion to each partner's proportionate share of Property A
both before and after the distribution. Half of the depreciation
deductions attributable to the $40x section 734(b) step-up will be
allocated to DC. In addition, DC's proportionate share of Property A
increased from one-third to one-half and therefore DC will be
allocated depreciation deductions with respect to half of the
original basis of $60x (or $30x) instead of one-third of $60x (or
$20x).
(B) Analysis. Distributions of property that cause an increase
in the tax basis of property that continues to be held by the
partnership are analyzed under paragraph (c)(4) of this section. The
$40x increase in the tax basis of Property A as a result of the
distribution of cash to FC is treated as newly purchased property
acquired from FC under paragraph (c)(4) of this section and
therefore acquired with a base erosion payment under Sec. 1.59A-
3(b)(1)(ii) to DC to the extent of DC's proportionate share. DC's
base erosion tax benefit is the amount of DC's depreciation
deductions attributable to that base erosion payment, which is DC's
distributive share of the depreciation deductions with respect to
the $40x increase in the tax basis of Property A. See Sec. 1.59A-
7(d)(1). In addition, FC transferred a partnership interest to DC
(as defined in paragraph (c)(3)(iv) of this section), which is
analyzed under paragraph (c)(3)(i) of this section. Under paragraph
(c)(3)(i) of this section, DC is deemed to acquire a one-sixth
interest in Property A from FC (the increase in DC's proportionate
share from one-third to one-half). DC's base erosion tax benefit
from this additional one-sixth interest in Property A is the amount
of DC's depreciation deductions attributable to this interest.
(viii) Example 8: Distribution of property by a partnership to a
taxpayer--(A) Facts. The facts are the same as paragraph
(g)(2)(vii)(A) of this section (the facts of Example 7), except that
PRS's depreciable property consists of two assets, Property A having
a fair market value of $90x and a tax basis of $60x and Property B
having a fair market value of $90x and a tax basis of zero. Instead
of distributing cash to FC, PRS distributes Property B to DC in
liquidation of its interest, resulting in an increase in the basis
of the distributed Property B to DC of $50x (from zero to $50x)
under section 732(b) because DC's tax basis in the PRS interest was
$50x. For section 59A purposes, prior to the distribution, each
partner had a one-third proportionate share of Property B and after
the distribution, the property is wholly owned by DC.
(B) Analysis. Distributions of property that cause an increase
in the tax basis of property that is distributed to a taxpayer are
analyzed under paragraph (c)(4) of this section. Under paragraph
(c)(4) of this section, the $50x increase in tax basis is treated as
newly purchased property that was acquired with a base erosion
payment to the extent that the increase in tax basis is attributable
to FC. Under paragraph (c)(4) of this section, the portion of the
increase that is attributable to FC is the proportionate share of
the Property B immediately before the distribution that was treated
as owned by FC. Immediately before the distribution, FC had a one-
third proportionate share of Property B. Accordingly, one-third of
the $50x increase in the tax basis of Property B is treated as if it
was newly purchased property acquired by DC from FC with a base
erosion payment under Sec. 1.59A-3(b)(1)(ii). DC's base erosion tax
benefit is the amount of DC's depreciation deductions with respect
to the base erosion payment, which in this case is the depreciation
deductions with respect to the one-third interest in the increased
basis treated as newly purchased property deemed acquired from FC.
See Sec. 1.59A-3(c)(1). In addition, PRS transferred Property B to
DC, which is analyzed under paragraph (c)(2) of this section. Prior
to the distribution, DC, FC, and UC each owned one-third of Property
B. After the distribution, DC entirely owned Property B. Therefore,
under paragraph (c)(2) of this section, DC is treated as acquiring
one-third of Property B from FC. DC's depreciation deductions with
respect to the one-third of Property B acquired from FC (without
regard to the basis increase) is also a base erosion tax benefit.
(ix) Example 9: Distribution of property by a partnership in
liquidation of a foreign related party's interest--(A) Facts. The
facts are the same as paragraph (g)(2)(viii)(A) (the facts of
Example 8), except that Property B is not distributed to DC and,
instead, Property A is distributed to FC in liquidation of its
interest, resulting in a tax basis in Property A of $50x in FC's
hands under section 732(b) and a section 734(b) step-up in Property
B of $10x (because Property A's tax basis was reduced from $60x to
$50x), allocable to DC and UC. For section 59A purposes, prior to
the distribution, each partner had a one-third proportionate share
of Property B and after the distribution, DC and UC each have a one-
half proportionate share of Property B.
(B) Analysis. Distributions of property that cause an increase
in the tax basis of property that continues to be held by the
partnership are analyzed under paragraph (c)(4) of this section.
Under paragraph (c)(4) of this section, because the distribution of
Property A to FC from PRS caused an increase in the tax basis of
Property B, the entire $10x increase in tax basis is treated as
newly purchased property that was acquired with a base erosion
payment under Sec. 1.59A-3(b)(1)(ii). DC's base erosion tax benefit
is the amount of DC's depreciation deductions attributable to the
base erosion payment, which is DC's distributive share of the
depreciation deductions with respect to the $10x increase in the tax
basis of Property B. See Sec. 1.59A-7(d)(1). In addition, under
paragraph (c)(3)(i) of this section, DC is deemed to acquire a one-
sixth interest in Property B from FC (the increase in DC's
proportionate share from one-third to one-half). While this increase
is a base erosion payment under Sec. 1.59A-3(b)(1)(ii), there is no
base erosion tax benefit from this additional one-sixth interest in
Property B because the
[[Page 67037]]
tax basis in Property B (without regard to the basis) is zero and
therefore the increase in DC's proportionate share does not result
in any additional depreciation deductions.
Sec. 1.59A-8 [Reserved]
Sec. 1.59A-9 Anti-abuse and recharacterization rules.
(a) Scope. This section provides rules for recharacterizing certain
transactions according to their substance for purposes of applying
section 59A and the section 59A regulations. Paragraph (b) of this
section provides specific anti-abuse rules. Paragraph (c) of this
section provides examples illustrating the rules of paragraph (b) of
this section.
(b) Anti-abuse rules--(1) Transactions involving unrelated persons,
conduits, or intermediaries. If a taxpayer pays or accrues an amount to
one or more intermediaries (including an intermediary unrelated to the
taxpayer) that would have been a base erosion payment if paid or
accrued to a foreign related party, and one or more of the
intermediaries makes (directly or indirectly) corresponding payments to
or for the benefit of a foreign related party as part of a transaction
(or series of transactions), plan or arrangement that has as a
principal purpose avoiding a base erosion payment (or reducing the
amount of a base erosion payment), the role of the intermediary or
intermediaries is disregarded as a conduit, or the amount paid or
accrued to the intermediary is treated as a base erosion payment, as
appropriate.
(2) Transactions to increase the amount of deductions taken into
account in the denominator of the base erosion percentage computation.
A transaction (or component of a transaction or series of
transactions), plan or arrangement that has a principal purpose of
increasing the deductions taken into account for purposes of Sec.
1.59A-2(e)(3)(i)(B) (the denominator of the base erosion percentage
computation) is disregarded for purposes of Sec. 1.59A-2(e)(3).
(3) Transactions to avoid the application of rules applicable to
banks and registered securities dealers. A transaction (or series of
transactions), plan or arrangement that occurs among related parties
that has a principal purpose of avoiding the rules applicable to
certain banks and registered securities dealers in Sec. 1.59A-2(e)(2)
(base erosion percentage test for banks and registered securities
dealers) or Sec. 1.59A-5(c)(2) (increased base erosion and anti-abuse
tax rate for banks and registered securities dealers) is not taken into
account for purposes of Sec. 1.59A-2(e)(2) or Sec. 1.59A-5(c)(2).
(4) Nonrecognition transactions. If a transaction (or series of
transactions), plan or arrangement, has a principal purpose of
increasing the adjusted basis of property that a taxpayer acquires in a
specified nonrecognition transaction, then Sec. 1.59A-3(b)(3)(viii)(A)
will not apply to the specified nonrecognition transaction. For
purposes of this paragraph (b)(4), if a transaction (or series of
transactions), plan or arrangement between related parties increases
the adjusted basis of property within the six month period before the
taxpayer acquires the property in a specified nonrecognition
transaction, the transaction (or series of transactions), plan or
arrangement is deemed to have a principal purpose of increasing the
adjusted basis of property that a taxpayer acquires in a nonrecognition
transaction.
(c) Examples. The following examples illustrate the application of
this section.
(1) Facts. The following facts are assumed for purposes of the
examples.
(i) DC is a domestic corporation that is an applicable taxpayer for
purposes section 59A.
(ii) FP is a foreign corporation that owns all the stock of DC.
(iii) None of the foreign corporations have income that is, or is
treated as, effectively connected with the conduct of a trade or
business in the United States under an applicable provision of the
Internal Revenue Code or regulations thereunder.
(iv) All payments occur in a taxable year beginning after December
31, 2017.
(2) Example 1: Substitution of payments that are not base
erosion payments for payments that otherwise would be base erosion
payments through a conduit or intermediary--(i) Facts. FP owns
Property 1 with a fair market value of $95x, which FP intends to
transfer to DC. A payment from DC to FP for Property 1 would be a
base erosion payment. Corp A is a domestic corporation that is not a
related party with respect to DC. As part of a plan with a principal
purpose of avoiding a base erosion payment, FP enters into an
arrangement with Corp A to transfer Property 1 to Corp A in exchange
for $95x. Pursuant to the same plan, Corp A transfers Property 1 to
DC in exchange for $100x. Property 1 is subject to the allowance for
depreciation (or amortization in lieu of depreciation) in the hands
of DC.
(ii) Analysis. The arrangement between FP, DC, and Corp A is
deemed to result in a $95x base erosion payment under paragraph
(b)(1) of this section because DC's payment to Corp A would have
been a base erosion payment if paid to a foreign related party, and
Corp A makes a corresponding payment to FP as part of the series of
transactions that has as a principal purpose avoiding a base erosion
payment.
(3) Example 2: Alternative transaction to base erosion payment--
(i) Facts. The facts are the same as in paragraph (c)(2)(i) of this
section (the facts in Example 1), except that DC does not purchase
Property 1 from FP or Corp A. Instead, DC purchases Property 2 from
Corp B, a domestic corporation that is not a related party with
respect to DC and that originally produced or acquired Property 2
for Corp B's own account. Property 2 is substantially similar to
Property 1, and DC uses Property 2 in substantially the same manner
that DC would have used Property 1.
(ii) Analysis. Paragraph (b)(1) of this section does not apply
to the transaction between DC and Corp B because Corp B does not
make a corresponding payment to or for the benefit of FP as part of
a transaction, plan or arrangement.
(4) Example 3: Alternative financing source--(i) Facts. On Date
1, FP loaned $200x to DC in exchange for Note A. DC pays or accrues
interest annually on Note A, and the payment or accrual is a base
erosion payment within the meaning of Sec. 1.59A-3(b)(1)(i). On
Date 2, DC borrows $200x from Bank, a corporation that is not a
related party with respect to DC, in exchange for Note B. The terms
of Note B are substantially similar to the terms of Note A. DC uses
the proceeds from Note B to repay Note A.
(ii) Analysis. Paragraph (b)(1) of this section does not apply
to the transaction between DC and Bank because Bank does not make a
corresponding payment to or for the benefit of FP as part of the
series of transactions.
(5) Example 4: Alternative financing source that is a conduit--
(i) Facts. The facts are the same as in paragraph (c)(4)(i) of this
section (the facts in Example 3) except that in addition, as part of
the same plan or arrangement as the Note B transaction and with a
principal purpose of avoiding a base erosion payment, FP deposits
$250x with Bank. The difference between the interest rate paid by
Bank to FP on FP's deposit and the interest rate paid by DC to Bank
is less than one percentage point. The interest rate charged by Bank
to DC would have differed absent the deposit by FP.
(ii) Analysis. The transactions between FP, DC, and Bank are
deemed to result in a base erosion payment under paragraph (b)(1) of
this section because DC's payment to Bank would have been a base
erosion payment if paid to a foreign related party, and Bank makes a
corresponding payment to FP as part of the series of transactions
that has as a principal purpose avoiding a base erosion payment. See
Rev. Rul. 87-89, 1987-2 C.B. 195, Situation 3.
(6) Example 5: Intermediary acquisition--(i) Facts. FP owns all
of the stock of DC1 and DC2, each domestic corporations. FP is a
manufacturer of lawn equipment. DC1 is in the trade or business of
renting equipment to unrelated third parties. DC2 is a dealer in
property that capitalizes its purchases into inventory and recovers
the amount through cost of goods sold. Before Date 1, in the
ordinary course of DC1's business, DC1 acquired depreciable property
from FP that DC1 in turn rented to unrelated third parties. DC1's
purchases from FP were base erosion payments within the meaning of
Sec. 1.59A-3(b)(1)(ii). On Date 1, with a principal purpose of
avoiding a base erosion payment,
[[Page 67038]]
FP and DC2 reorganized their operations so that DC2 acquires the
lawn equipment from FP and immediately thereafter, DC2 resells the
lawn equipment to DC1.
(ii) Analysis. The transactions between FP, DC1, and DC2 are
deemed to result in a base erosion payment under paragraph (b)(1) of
this section because DC1's payment to DC2 would have been a base
erosion payment if paid directly to FP, and DC2 makes a
corresponding payment to FP as part of a series of transactions,
plan, or arrangement that has a principal purpose of avoiding a base
erosion payment from DC1 to FP.
(7) Example 6: Offsetting transactions to increase the amount of
deductions taken into account in the denominator of the base erosion
percentage computation--(i) Facts. With a principal purpose of
increasing the deductions taken into account by DC for purposes of
Sec. 1.59A-2(e)(3)(i)(B), DC enters into a long position with
respect to Asset with Financial Institution 1 and simultaneously
enters into a short position with respect to Asset with Financial
Institution 2. Financial Institution 1 and Financial Institution 2
are not related to DC and are not related to each other.
(ii) Analysis. Paragraph (b)(2) of this section applies to the
transactions between DC and Financial Institution 1 and DC and
Financial Institution 2. These transactions are not taken into
account for purposes of Sec. 1.59A-2(e)(3)(i)(B) because the
transactions have a principal purpose of increasing the deductions
taken into account for purposes of Sec. 1.59A-2(e)(3)(i)(B).
(8) Example 7: Ordinary course transactions that increase the
amount of deductions taken into account in the denominator of the
base erosion percentage computation--(i) Facts. DC, a financial
institution, enters into a long position with respect to stock in
Corporation with Person 1 and later on the same day enters into a
short position with respect to stock in Corporation with Person 2.
Person 1 and Person 2 are not related to DC and are not related to
each other. DC entered into the positions in the ordinary course of
its business and did not have a principal purpose of increasing the
deductions taken into account by DC for purposes of Sec. 1.59A-
2(e)(3)(i)(B).
(ii) Analysis. Paragraph (b)(2) of this section does not apply
because the transactions between DC and Person 1 and Person 2 were
not entered into with a principal purpose of increasing the
deductions taken into account by DC for purposes of Sec. 1.59A-
2(e)(3)(i)(B).
(9) Example 8: Transactions to avoid the application of rules
applicable to banks and registered securities dealers--(i) Facts. DC
owns all of the stock of DC1 and Bank (an entity defined in section
581). DC, DC1, and Bank are members of an affiliated group of
corporations within the meaning of section 1504(a) that elect to
file a consolidated U.S. federal income tax return. With a principal
purpose of avoiding the rules of Sec. 1.59A-2(e)(2) or Sec. 1.59A-
5(c)(2), DC and DC1 form a new partnership (PRS). DC contributes all
of its stock of Bank, and DC1 contributes cash, to PRS. DC, DC1, and
Bank do not materially change their business operations following
the formation of PRS.
(ii) Analysis. Paragraph (b)(3) of this section applies to
transactions with respect to Bank because the transactions with
respect to PRS were entered into with a principal purpose of
avoiding the rules of Sec. 1.59A-2(e)(2) or Sec. 1.59A-5(c)(2).
The contribution of Bank to a PRS is not taken into account, and
Bank will be deemed to be part of the affiliated group including DC
and DC1 for purposes of Sec. 1.59A-2(e)(2) and Sec. 1.59A-5(c)(2).
(10) Example 9: Transactions that do not avoid the application
of rules applicable to banks and registered securities dealers--(i)
Facts. The facts are the same as the facts of paragraph (c)(9)(i) of
this section (the facts of Example 8), except that DC sells 90
percent of the stock of Bank to an unrelated party in exchange for
cash.
(ii) Analysis. Paragraph (b)(3) of this section does not apply
to DC's sale of the stock of Bank because the sale was not made with
a principal purpose of avoiding the rules of Sec. 1.59A-2(e)(2) or
Sec. 1.59A-5(c)(2). Bank will not be treated as part of the
affiliated group including DC and DC1 for purposes of Sec. 1.59A-
2(e)(2) and Sec. 1.59A-5(c)(2).
(11) Example 10: Acquisition of depreciable property in a
nonrecognition transaction--(i) Facts. U, which is not a related
party with respect to FP or DC, owns Property 1 with an adjusted
basis of $50x and a fair market value of $100x. On Date 1, FP
purchases property, including Property 1, from U in exchange for
cash, and then FP contributes Property 1 to DC in an exchange
described in section 351. Following the exchange, DC's basis in
Property 1 is $100x.
(ii) Analysis. Paragraph (b)(4) of this section does not apply
to DC's acquisition of Property 1 because the purchase of Property 1
from U (along with the purchase of other property from U that FP did
not contribute to DC) did not have a principal purpose of increasing
the adjusted basis of property that was subsequently transferred to
DC. The transaction is economically equivalent to an alternative
transaction under which FP contributed $100x to DC and then DC
purchased Property 1 from U. Further, the second sentence of
paragraph (b)(4) of this section (providing that certain
transactions are deemed to have a principal purpose of increasing
the adjusted basis of property that a taxpayer acquires in a
nonrecognition transaction) does not apply because FP purchased
Property 1 from an unrelated party.
(12) Example 11: Transactions between related parties with a
principal purpose of increasing the adjusted basis of property--(i)
Facts. The facts are the same as paragraph (c)(11)(i) of this
section (the facts in Example 10), except that U is related to FP
and DC.
(ii) Analysis. Paragraph (b)(4) of this section applies to DC's
acquisition of Property 1 because the transaction that increased the
adjusted basis of Property 1 (the purchase of Property 1 from U) was
between related parties, and within six months DC acquired Property
1 from FP in a specified nonrecognition transaction. Accordingly,
the purchase of property from U is deemed to have a principal
purpose of increasing the adjusted basis of Property 1, the
exception in Sec. 1.59A-3(b)(3)(viii)(A) for specified
nonrecognition transactions will not apply to the contribution of
Property 1 to DC, and DC's depreciation deductions with respect to
Property 1 will be base erosion tax benefits.
Sec. 1.59A-10 Applicability date.
Sections 1.59A-1 through 1.59A-9 apply to taxable years ending on
or after December 17, 2018. However, taxpayers may apply these final
regulations in their entirety for taxable years beginning after
December 31, 2017, and ending before December 17, 2018. In lieu of
applying these final regulations, taxpayers may apply the provisions
matching Sec. Sec. 1.59A-1 through 1.59A-9 from the Internal Revenue
Bulletin (IRB) 2019-02 (https://www.irs.gov/pub/irs-irbs/irb19-02.pdf)
in their entirety for all taxable years ending on or before December 6,
2019.
0
Par. 3. Section 1.383-1 is amended by adding two sentences at the end
of paragraph (d)(3)(i) to read as follows:
Sec. 1.383-1 Special limitations on certain capital losses and excess
credits.
* * * * *
(d) * * *
(3) * * *
(i) * * * The application of section 59A is not a limitation
contained in subtitle A for purposes of this paragraph (d)(3)(i).
Therefore, the treatment of pre-change losses and pre-change credits in
the computation of the base erosion minimum tax amount will not affect
whether such losses or credits result in absorption of the section 382
limitation and the section 383 credit limitation.
* * * * *
0
Par. 4. Section 1.1502-2 is revised to read as follows:
Sec. 1.1502-2 Computation of tax liability.
(a) Taxes imposed. The tax liability of a group for a consolidated
return year is determined by adding together--
(1) The tax imposed by section 11(a) in the amount described in
section 11(b) on the consolidated taxable income for the year (reduced
by the taxable income of a member described in paragraphs (a)(5)
through (8) of this section);
(2) The tax imposed by section 541 on the consolidated
undistributed personal holding company income;
(3) If paragraph (a)(2) of this section does not apply, the
aggregate of the taxes imposed by section 541 on the separate
undistributed personal holding company income of the members which are
personal holding companies;
(4) If neither paragraph (a)(2) nor (3) of this section apply, the
tax imposed by section 531 on the consolidated accumulated taxable
income (see Sec. 1.1502-43);
[[Page 67039]]
(5) The tax imposed by section 594(a) in lieu of the taxes imposed
by section 11 on the taxable income of a life insurance department of
the common parent of a group which is a mutual savings bank;
(6) The tax imposed by section 801 on consolidated life insurance
company taxable income;
(7) The tax imposed by section 831(a) on consolidated insurance
company taxable income of the members which are subject to such tax;
(8) Any increase in tax described in section 1351(d)(1) (relating
to recoveries of foreign expropriation losses); and
(9) The tax imposed by section 59A on base erosion payments of
taxpayers with substantial gross receipts.
(b) Credits. A group is allowed as a credit against the taxes
described in paragraph (a) of this section (except for paragraph (a)(9)
of this section) of this section: The general business credit under
section 38 (see Sec. 1.1502-3), the foreign tax credit under section
27 (see Sec. 1.1502-4), and any other applicable credits provided
under the Internal Revenue Code. Any increase in tax due to the
recapture of a tax credit will be taken into account. See section 59A
and the regulations thereunder for credits allowed against the tax
described in paragraph (a)(9) of this section.
(c) Allocation of dollar amounts. For purposes of this section, if
a member or members of the consolidated group are also members of a
controlled group that includes corporations that are not members of the
consolidated group, any dollar amount described in any section of the
Internal Revenue Code is apportioned among all members of the
controlled group in accordance with the provisions of the applicable
section and the regulations thereunder.
(d) Applicability date--This section applies to taxable years for
which the original consolidated Federal income tax return is due
(without extension) after December 6, 2019.
0
Par. 5 Section 1.1502-4 is amended by revising paragraph (d)(3) to read
as follows:
Sec. 1.1502-4 Consolidated foreign tax credit.
* * * * *
(d) * * *
(3) Computation of tax against which credit is taken. The tax
against which the limiting fraction under section 904(a) is applied
will be the consolidated tax liability of the group determined under
Sec. 1.1502-2, but without regard to paragraphs (a)(2), (3), (4), (8),
and (9) of that section, and without regard to any credit against such
liability.
* * * * *
0
Par. 6. Section 1.1502-43 is amended by revising paragraph (b)(2)(i)(A)
to read as follows:
Sec. 1.1502-43 Consolidated accumulated earnings tax.
* * * * *
(b) * * *
(2) * * *
(i) * * *
(A) The consolidated liability for tax determined without Sec.
1.1502-2(a)(2) through (4), and without the foreign tax credit provided
by section 27, over
* * * * *
0
Par. 7. Section 1.1502-47 is amended by revising paragraph (f)(7)(iii)
to read as follows.
Sec. 1.1502-47 Consolidated returns by life-nonlife groups.
* * * * *
(f) * * *
(7) * * *
(iii) Any taxes described in Sec. 1.1502-2 (other than by
paragraphs (a)(1) and (6) of that section).
* * * * *
0
Par. 8. Section 1.1502-59A is added to read as follows:
Sec. 1.1502-59A Application of section 59A to consolidated groups.
(a) Scope. This section provides rules for the application of
section 59A and the regulations thereunder (the section 59A
regulations) to consolidated groups and their members (as defined in
Sec. 1.1502-1(h) and (b), respectively). Rules in the section 59A
regulations apply to consolidated groups except as modified in this
section. Paragraph (b) of this section provides rules treating a
consolidated group (rather than each member of the group) as a single
taxpayer, and a single applicable taxpayer, as relevant, for certain
purposes. Paragraph (c) of this section coordinates the application of
the business interest stacking rule under Sec. 1.59A-3(c)(4) to
consolidated groups. Paragraph (d) of this section addresses how the
base erosion minimum tax amount is allocated among members of the
consolidated group. Paragraph (e) of this section coordinates the
application of this section and Sec. 1.1502-47. Paragraph (f) of this
section sets forth definitions. Paragraph (g) of this section provides
examples. Paragraph (h) of this section provides the applicability
date.
(b) Consolidated group as the applicable taxpayer--(1) In general.
For purposes of determining whether the consolidated group is an
applicable taxpayer (within the meaning of Sec. 1.59A-2(b)) and the
amount of tax due pursuant to section 59A(a), all members of a
consolidated group are treated as a single taxpayer. Thus, for example,
members' deductions are aggregated in making the required computations
under section 59A. In addition, to ensure that intercompany
transactions (as defined in Sec. 1.1502-13(b)(1)(i)) do not affect the
consolidated group's base erosion percentage or base erosion minimum
tax amount, items resulting from intercompany transactions are not
taken into account in making such computations under section 59A. For
example, additional depreciation deductions resulting from intercompany
asset sales are not taken into account for purposes of applying the
base erosion percentage test under Sec. 1.59A-2(e).
(2) Consolidated group as member of the aggregate group. The
consolidated group is treated as a single member of an aggregate group
for purposes of Sec. 1.59A-2(c).
(3) Related party determination. For purposes of section 59A and
the section 59A regulations, if a person is a related party with
respect to any member of a consolidated group, that person is a related
party of the group and of each of its members.
(c) Coordination of section 59A(c)(3) and section 163(j) in a
consolidated group--(1) Overview. This paragraph (c) provides rules
regarding the application of Sec. 1.59A-3(c)(4) to a consolidated
group's section 163(j) interest deduction. The classification rule in
paragraph (c)(3) of this section addresses how to determine if, and to
what extent, the group's section 163(j) interest deduction is a base
erosion tax benefit. These regulations contain a single-entity
classification rule with regard to the deduction of the consolidated
group's aggregate current year business interest expense (``BIE''), but
a separate-entity classification rule for the deduction of the
consolidated group's disallowed BIE carryforwards. Paragraph (c)(3) of
this section classifies the group's aggregate current year BIE
deduction, in conformity with Sec. 1.59A-3(c)(4), as constituting
domestic related current year BIE deduction, foreign related current
year BIE deduction, or unrelated current year BIE deduction. The
allocation rules in paragraph (c)(4) of this section then allocate to
specific members of the group the domestic related current year BIE
deduction, foreign related current year BIE deduction, and unrelated
current year BIE deduction taken in the taxable year. Any member's
current year BIE that is carried forward to the succeeding taxable year
as a disallowed BIE carryforward is allocated a status as domestic
related BIE carryforward, foreign related BIE carryforward, or
unrelated BIE carryforward under
[[Page 67040]]
paragraph (c)(5) of this section. The status of any disallowed BIE
carryforward deducted by a member in a later year is classified on a
separate-entity basis by the deducting member under paragraph (c)(3) of
this section, based on the status allocated to the member's disallowed
BIE carryforward under paragraph (c)(5) of this section. This paragraph
(c) also provides rules regarding the consequences of the
deconsolidation of a corporation that has been allocated a domestic
related BIE carryforward status, a foreign related BIE carryforward
status, or an unrelated BIE carryforward status; and the consolidation
of a corporation with a disallowed BIE carryforward classified as from
payments to a domestic related party, foreign related party, or
unrelated party.
(2) Absorption rule for the group's business interest expense. To
determine the amount of the group's section 163(j) interest deduction,
and to determine the year in which the member's business interest
expense giving rise to the deduction was incurred or accrued, see
Sec. Sec. 1.163(j)-4(d) and 1.163(j)-5(b)(3).
(3) Classification of the group's section 163(j) interest
deduction--(i) In general. Consistent with Sec. 1.59A-3(c)(4)(i) and
paragraph (b) of this section, the classification rule of this
paragraph (c)(3) determines whether the consolidated group's section
163(j) interest deduction is a base erosion tax benefit. To the extent
the consolidated group's business interest expense is permitted as a
deduction under section 163(j)(1) in a taxable year, the deduction is
classified first as from business interest expense paid or accrued to a
foreign related party and business interest expense paid or accrued to
a domestic related party (on a pro-rata basis); any remaining deduction
is treated as from business interest expense paid or accrued to an
unrelated party.
(ii) Year-by-year application of the classification rule. If the
consolidated group's section 163(j) interest deduction in any taxable
year is attributable to business interest expense paid or accrued in
more than one taxable year (for example, the group deducts the group's
aggregate current year BIE, the group's disallowed BIE carryforward
from year 1, and the group's disallowed BIE carryforward from year 2),
the classification rule in paragraph (c)(3)(i) of this section applies
separately to each of those years, pursuant to paragraphs (c)(3)(iii)
and (iv) of this section.
(iii) Classification of current year BIE deductions. Current year
BIE deductions are classified under the section 59A regulations and
this paragraph (c) as if the consolidated group were a single taxpayer
that had paid or accrued the group's aggregate current year BIE to
domestic related parties, foreign related parties, and unrelated
parties. The rules of paragraph (c)(4) of this section apply for
allocating current year BIE deductions among members of the
consolidated group. To the extent the consolidated group's aggregate
current year BIE exceeds its section 163(j) limitation, the rules of
paragraph (c)(5) of this section apply.
(iv) Classification of deductions of disallowed BIE carryforwards.
Each member of the group applies the classification rule in this
paragraph (c)(3) to its deduction of any part of a disallowed BIE
carryforward from a year, after the group applies paragraph (c)(5) of
this section to the consolidated group's disallowed BIE carryforward
from that year. Therefore, disallowed BIE carryforward that is actually
deducted by a member is classified based on the status of the
components of that carryforward, assigned pursuant to paragraph (c)(5)
of this section.
(4) Allocation of domestic related current year BIE deduction
status and foreign related current year BIE deduction status among
members of the consolidated group--(i) In general. This paragraph
(c)(4) applies if the group has domestic related current year BIE
deductions, foreign related current year BIE deductions, or both, as a
result of the application of the classification rule in paragraph
(c)(3) of this section. Under this paragraph (c)(4), the domestic
related current year BIE, foreign related current year BIE, or both,
that is treated as deducted in the current year are deemed to have been
incurred pro-rata by all members that have current year BIE deduction
in that year, regardless of which member or members actually incurred
the current year BIE to a domestic related party or a foreign related
party.
(ii) Domestic related current year BIE deduction--(A) Amount of
domestic related current year BIE deduction status allocable to a
member. The amount of domestic related current year BIE deduction
status that is allocated to a member is determined by multiplying the
group's domestic related current year BIE deduction (determined
pursuant to paragraph (c)(3) of this section) by the percentage of
current year BIE deduction allocable to such member in that year.
(B) Percentage of current year BIE deduction allocable to a member.
The percentage of current year BIE deduction allocable to a member is
equal to the amount of the member's current year BIE deduction divided
by the amount of the group's aggregate current year BIE deduction.
(iii) Amount of foreign related current year BIE deduction status
allocable to a member. The amount of foreign related current year BIE
deduction status that is allocated to a member is determined by
multiplying the group's foreign related current year BIE deduction
(determined pursuant to paragraph (c)(3) of this section) by the
percentage of current year BIE deduction allocable to such member
(defined in paragraph (c)(4)(ii)(B) of this section).
(iv) Treatment of amounts as having unrelated current year BIE
deduction status. To the extent the amount of a member's current year
BIE that is absorbed under paragraph (c)(2) of this section exceeds the
domestic related current year BIE deduction status and foreign related
current year BIE deduction status allocated to the member under
paragraph (c)(4)(ii) and (iii) of this section, such excess amount is
treated as from payments or accruals to an unrelated party.
(5) Allocation of domestic related BIE carryforward status and
foreign related BIE carryforward status to members of the group--(i) In
general. This paragraph (c)(5) applies in any year the consolidated
group's aggregate current year BIE exceeds its section 163(j)
limitation. After the application of paragraph (c)(4) of this section,
any remaining domestic related current year BIE, foreign related
current year BIE, and unrelated current year BIE is deemed to have been
incurred pro-rata by members of the group pursuant to the rules in
paragraph (c)(5)(ii), (iii), and (iv) of this section, regardless of
which member or members actually incurred the business interest expense
to a domestic related party, foreign related party, or unrelated party.
(ii) Domestic related BIE carryforward--(A) Amount of domestic
related BIE carryforward status allocable to a member. The amount of
domestic related BIE carryforward status that is allocated to a member
equals the group's domestic related BIE carryforward from that year
multiplied by the percentage of disallowed BIE carryforward allocable
to the member.
(B) Percentage of disallowed BIE carryforward allocable to a
member. The percentage of disallowed BIE carryforward allocable to a
member for a taxable year equals the member's disallowed BIE
carryforward from that year divided by the consolidated group's
disallowed BIE carryforwards from that year.
(iii) Amount of foreign related BIE carryforward status allocable
to a member. The amount of foreign related
[[Page 67041]]
BIE carryforward status that is allocated to a member equals the
group's foreign related BIE carryforward from that year multiplied by
the percentage of disallowed BIE carryforward allocable to the member
(as defined in paragraph (c)(5)(ii)(B) of this section).
(iv) Treatment of amounts as having unrelated BIE carryforward
status. If a member's disallowed BIE carryforward for a year exceeds
the amount of domestic related BIE carryforward status and foreign
related BIE carryforward status that is allocated to the member
pursuant to paragraphs (c)(5)(ii) and (iii) of this section,
respectively, the excess carryforward amount is treated as from
payments or accruals to an unrelated party.
(v) Coordination with section 381. If a disallowed BIE carryforward
is allocated a status as a domestic related BIE carryforward, foreign
related BIE carryforward, or unrelated BIE carryforward under the
allocation rule of paragraph (c)(5) of this section, the acquiring
corporation in a transaction described in section 381(a) will succeed
to and take into account the allocated status of the carryforward for
purposes of section 59A. See Sec. 1.381(c)(20)-1.
(6) Member deconsolidates from a consolidated group--(i) General
rule. When a member deconsolidates from a group (the original group),
the member's disallowed BIE carryforwards retain their allocated
status, pursuant to paragraph (c)(5) of this section, as a domestic
related BIE carryforward, foreign related BIE carryforward, or
unrelated BIE carryforward (as applicable). Following the member's
deconsolidation, the status of the disallowed BIE carryforwards of the
remaining members is not redetermined.
(ii) Gross receipts exception. This paragraph (c)(6)(ii) applies if
the original group had insufficient gross receipts to satisfy the gross
receipts test under Sec. 1.59A-2(d) and thus was not an applicable
taxpayer in the year in which the deconsolidating member's disallowed
BIE carryforward was incurred. If this paragraph (c)(6)(ii) applies,
the deconsolidating member may determine the status of its disallowed
BIE carryforward from that year by applying the classification rule of
Sec. 1.59A-3(c)(4) solely to the interest payments or accruals of the
deconsolidating member, rather than by applying Sec. 1.1502-59A(c)(3).
(iii) Failure to substantiate. If the deconsolidating member fails
to substantiate a disallowed BIE carryforward as a domestic related BIE
carryforward, foreign related BIE carryforward, or unrelated BIE
carryforward, then the disallowed BIE carryforward is treated as a
foreign related BIE carryforward.
(7) Corporation joins a consolidated group. If a corporation joins
a consolidated group (the acquiring group), and that corporation was
allocated a domestic related BIE carryforward status, foreign related
BIE carryforward status, or unrelated BIE carryforward status pursuant
to paragraph (c)(5) of this section from another consolidated group
(the original group), or separately has a disallowed BIE carryforward
that is classified as from payments or accruals to a domestic related
party, foreign related party, or unrelated party, the status of the
carryforward is taken into account in determining the acquiring group's
base erosion tax benefit when the corporation's disallowed BIE
carryforward is absorbed.
(d) Allocation of the base erosion minimum tax amount to members of
the consolidated group. For rules regarding the allocation of the base
erosion minimum tax amount, see section 1552. Allocations under section
1552 take into account the classification and allocation provisions of
paragraphs (c)(3) through (5) of this section.
(e) [Reserved]
(f) Definitions. The following definitions apply for purposes of
this section--
(1) Aggregate current year BIE. The consolidated group's aggregate
current year BIE is the aggregate of all members' current year BIE.
(2) Aggregate current year BIE deduction. The consolidated group's
aggregate current year BIE deduction is the aggregate of all members'
current year BIE deductions.
(3) Applicable taxpayer. The term applicable taxpayer has the
meaning provided in Sec. 1.59A-2(b).
(4) Base erosion minimum tax amount. The consolidated group's base
erosion minimum tax amount is the tax imposed under section 59A.
(5) Base erosion tax benefit. The term base erosion tax benefit has
the meaning provided in Sec. 1.59A-3(c)(1).
(6) Business interest expense. The term business interest expense,
with respect to a member and a taxable year, has the meaning provided
in Sec. 1.163(j)-1(b)(2), and with respect to a consolidated group and
a taxable year, has the meaning provided in Sec. 1.163(j)-
4(d)(2)(iii).
(7) Consolidated group's disallowed BIE carryforwards. The term
consolidated group's disallowed BIE carryforwards has the meaning
provided in Sec. 1.163(j)-5(b)(3)(i).
(8) Current year BIE. A member's current year BIE is the member's
business interest expense that would be deductible in the current
taxable year without regard to section 163(j) and that is not a
disallowed business interest expense carryforward from a prior taxable
year.
(9) Current year BIE deduction. A member's current year BIE
deduction is the member's current year BIE that is permitted as a
deduction in the taxable year.
(10) Domestic related BIE carryforward. The consolidated group's
domestic related BIE carryforward for any taxable year is the excess of
the group's domestic related current year BIE over the group's domestic
related current year BIE deduction (if any).
(11) Domestic related current year BIE. The consolidated group's
domestic related current year BIE for any taxable year is the
consolidated group's aggregate current year BIE paid or accrued to a
domestic related party.
(12) Domestic related current year BIE deduction. The consolidated
group's domestic related current year BIE deduction for any taxable
year is the portion of the group's aggregate current year BIE deduction
classified as from interest paid or accrued to a domestic related party
under paragraph (c)(3) of this section.
(13) Domestic related party. A domestic related party is a related
party that is not a foreign related party and is not a member of the
same consolidated group.
(14) Disallowed BIE carryforward. The term disallowed BIE
carryforward has the meaning provided in Sec. 1.163(j)-1(b)(9).
(15) Foreign related BIE carryforward. The consolidated group's
foreign related BIE carryforward for any taxable year, is the excess of
the group's foreign related current year BIE over the group's foreign
related current year BIE deduction (if any).
(16) Foreign related current year BIE. The consolidated group's
foreign related current year BIE for any taxable year is the
consolidated group's aggregate current year BIE paid or accrued to a
foreign related party.
(17) Foreign related current year BIE deduction. The consolidated
group's foreign related current year BIE deduction for any taxable year
is the portion of the consolidated group's aggregate current year BIE
deduction classified as from interest paid or accrued to a foreign
related party under paragraph (c)(3) of this section.
(18) Foreign related party. A foreign related party has the meaning
provided in Sec. 1.59A-1(b)(12).
(19) Related party. The term related party has the meaning provided
in
[[Page 67042]]
Sec. 1.59A-1(b)(17), but excludes members of the same consolidated
group.
(20) Section 163(j) interest deduction. The term section 163(j)
interest deduction means, with respect to a taxable year, the amount of
the consolidated group's business interest expense permitted as a
deduction pursuant to Sec. 1.163(j)-5(b)(3) in the taxable year.
(21) Section 163(j) limitation. The term section 163(j) limitation
has the meaning provided in Sec. 1.163(j)-1(b)(31).
(22) Unrelated BIE carryforward. The consolidated group's unrelated
BIE carryforward for any taxable year is the excess of the group's
unrelated current year BIE over the group's unrelated current year BIE
deduction.
(23) Unrelated current year BIE. The consolidated group's unrelated
current year BIE for any taxable year is the consolidated group's
aggregate current year BIE paid or accrued to an unrelated party.
(24) Unrelated current year BIE deduction. The consolidated group's
unrelated current year BIE deduction for any taxable year is the
portion of the group's aggregate current year BIE deduction classified
as from interest paid or accrued to an unrelated party under paragraph
(c)(3) of this section.
(25) Unrelated party. An unrelated party is a party that is not a
related party.
(g) Examples. The following examples illustrate the general
application of this section. For purposes of the examples, a foreign
corporation (FP) wholly owns domestic corporation (P), which in turn
wholly owns S1 and S2. P, S1, and S2 are members of a consolidated
group. The consolidated group is a calendar year taxpayer.
(1) Example 1: Computation of the consolidated group's base
erosion minimum tax amount. (i) The consolidated group is the
applicable taxpayer--(A) Facts. The members have never engaged in
intercompany transactions. For the 2019 taxable year, P, S1, and S2
were permitted the following amounts of deductions (within the
meaning of section 59A(c)(4)), $2,400x, $1,000x, and $2,600x; those
deductions include base erosion tax benefits of $180x, $370x, and
$230x. The group's consolidated taxable income for the year is
$150x. In addition, the group satisfies the gross receipts test in
Sec. 1.59A-2(d).
(B) Analysis. Pursuant to paragraph (b) of this section, the
receipts and deductions of P, S1, and S2 are aggregated for purposes
of making the computations under section 59A. The group's base
erosion percentage is 13% (($180x + $370x + $230x)/($2,400x +
$1,000x + $2,600x)). The consolidated group is an applicable
taxpayer under Sec. 1.59A-2(b) because the group satisfies the
gross receipts test and the group's base erosion percentage (13%) is
higher than 3%. The consolidated group's modified taxable income is
computed by adding back the members' base erosion tax benefits (and,
when the consolidated group has consolidated net operating loss
available for deduction, the consolidated net operating loss allowed
multiplied by the base erosion percentage) to the consolidated
taxable income, $930x ($150x + $180x + $370x + $230x). The group's
base erosion minimum tax amount is then computed as 10 percent of
the modified taxable income less the regular tax liability, $61.5x
($930x x 10%-$150x x 21%).
(ii) The consolidated group engages in intercompany
transactions--(A) Facts. The facts are the same as in paragraph
(g)(1)(i)(A) of this section (the facts in Example 1(i)), except
that S1 sold various inventory items to S2 during 2019. Such items
are depreciable in the hands of S2 (but would not have been
depreciable in the hands of S1) and continued to be owned by S2
during 2019.
(B) Analysis. The result is the same as paragraph (g)(1)(i)(A)
of this section (the facts in Example 1(i)). Pursuant to paragraph
(b)(2) of this section, items resulting from the intercompany sale
(for example, gross receipts, depreciation deductions) are not taken
into account in computing the group's gross receipts under Sec.
1.59A-2(d) and base erosion percentage under Sec. 1.59A-2(e)(3).
(2) Example 2: Business interest expense subject to section
163(j) and the group's domestic related current year BIE and foreign
related current year BIE for the year equals its section 163(j)
limitation--(i) Facts. During the current year (Year 1), P incurred
$150x of business interest expense to domestic related parties; S1
incurred $150x of business interest expense to foreign related
parties; and S2 incurred $150x of business interest expense to
unrelated parties. The group's section 163(j) limitation for the
year is $300x. After applying the rules in Sec. 1.163(j)-5(b)(3),
the group deducts $150x of P's Year 1 business interest expense, and
$75x each of S1 and S2's Year 1 business interest expense. Assume
the group is an applicable taxpayer for purposes of section 59A.
(ii) Analysis--(A) Application of the absorption rule in
paragraph (c)(2) of this section. Following the rules in section
163(j), the group's section 163(j) interest deduction for Year 1 is
$300x, and the entire amount is from members' Year 1 business
interest expense.
(B) Application of the classification rule in paragraph (c)(3)
of this section. Under paragraph (c)(3) of this section, the group's
aggregate current year BIE deduction of $300x is first classified as
payments or accruals to related parties (pro-rata among domestic
related parties and foreign related parties), and second as payments
or accruals to unrelated parties. For Year 1, the group has $150x of
domestic related current year BIE and $150x of foreign related
current year BIE, and the group's aggregate current year BIE
deduction will be classified equally among the related party
expenses. Therefore, $150x of the group's deduction is classified as
domestic related current year BIE deduction and $150x is classified
as a foreign related current year BIE deduction.
(C) Application of the allocation rule in paragraph (c)(4) of
this section. After the application of the classification rule in
paragraph (c)(3) of this section, the group has $150x each of
domestic related current year BIE deduction and foreign related
current year BIE deduction from the group's aggregate current year
BIE in Year 1. The domestic related current year BIE deduction and
foreign related current year BIE deduction will be allocated to P,
S1, and S2 based on each member's deduction of its Year 1 business
interest expense.
(1) Allocations to P. The percentage of current year BIE
deduction attributable to P is 50% (P's deduction of its Year 1
current year BIE, $150x, divided by the group's aggregate current
year BIE deduction for Year 1, $300x). Thus, the amount of domestic
related current year BIE deduction status allocated to P is $75x
(the group's domestic related current year BIE deduction, $150x,
multiplied by the percentage of current year BIE deduction allocable
to P, 50%); and the amount of foreign related current year BIE
deduction status allocated to P is $75x (the group's foreign related
current year BIE deduction, $150x, multiplied by the percentage of
current year BIE deduction allocable to P, 50%).
(2) Allocations to S1 and S2. The percentage of current year BIE
deduction attributable to S1 is 25% (S1's deduction of its Year 1
current year BIE, $75x, divided by the group's aggregate current
year BIE deduction for Year 1, $300x). Thus, the amount of domestic
related current year BIE deduction status allocated to S1 is $37.5x
(the group's domestic related current year BIE deduction, $150x,
multiplied by the percentage of current year BIE deduction allocable
to S1, 25%); and the amount of foreign related current year BIE
deduction status allocated to S1 is $37.5x (the group's foreign
related current year BIE deduction, $150x, multiplied by the
percentage of current year BIE deduction allocable to S1, 25%).
Because S2 also deducted $75 of its Year 1 current year BIE, S2's
deductions are allocated the same pro-rata status as those of S1
under this paragraph (f)(2)(ii)(C)(2).
(D) Application of the allocation rule in paragraph (c)(5) of
this section. Although the group will have disallowed BIE
carryforwards after Year 1 (the group's aggregate current year BIE
of $450x ($150x + $150x + $150x) exceeds the section 163(j)
limitation of $300x), all of the domestic related current year BIE
and foreign related current year BIE in Year 1 has been taken into
account pursuant to the classification rule in paragraph (c)(3) of
this section. Thus, under paragraph (c)(5)(iv) of this section, each
member's disallowed BIE carryforward is treated as from payments or
accruals to unrelated parties.
(3) Example 3: Business interest expense subject to section
163(j)--(i) The group's domestic related current year BIE and
foreign related current year BIE for the year exceeds its section
163(j) limitation. (A) Facts. During the current year (Year 1), P
incurred $60x of business interest expense to domestic related
parties; S1 incurred $40x of business interest expense to foreign
related parties; and S2 incurred $80x of business interest expense
to unrelated parties. The group's section 163(j) limitation for the
year is $60x. After applying
[[Page 67043]]
the rules in Sec. 1.163(j)-5(b)(3), the group deducts $20x each of
P, S1, and S2's current year business interest expense. Assume the
group is an applicable taxpayer for purposes of section 59A.
(B) Analysis--(1) Application of the absorption rule in
paragraph (c)(2) of this section. Following the rules in section
163(j), the group's section 163(j) interest deduction is $60x, and
the entire amount is from members' Year 1 business interest expense.
(2) Application of the classification rule in paragraph (c)(3)
of this section. Under paragraph (c)(3) of this section, the group's
$60x of aggregate current year BIE deduction is first classified as
payments or accruals to related parties (pro-rata among domestic
related parties and foreign related parties), and second as payments
or accruals from unrelated parties. The group's total related party
interest expense in Year 1, $100x (sum of the group's Year 1
domestic related current year BIE, $60x, and the group's Year 1
foreign related current year BIE, $40x), exceeds the group's
aggregate current year BIE deduction of $60x. Thus, the group's
aggregate current year BIE deduction will be classified, pro-rata,
as from payments or accruals to domestic related parties and foreign
related parties. Of the group's aggregate current year BIE deduction
in Year 1, $36x is classified as a domestic related current year BIE
deduction (the group's aggregate current year BIE deduction, $60x,
multiplied by the ratio of domestic related current year BIE over
the group's total Year 1 related party interest expense ($60x/($60x
+ $40x))); and $24x of the group's aggregate current year BIE
deduction is classified as a foreign related current year BIE
deduction (the group's section 163(j) interest deduction, $60x,
multiplied by the ratio of foreign related current year BIE over the
group's total Year 1 related party interest expense ($40x/($60x +
$40x))).
(3) Application of the allocation rule in paragraph (c)(4) of
this section. After the application of the classification rule in
paragraph (c)(3) of this section, the group has $36x of domestic
related current year BIE deduction and $24x of foreign related
current year BIE deduction from the group's aggregate current year
BIE in Year 1. The domestic related current year BIE deduction and
foreign related current year BIE deduction will be allocated to P,
S1, and S2 based on each member's current year BIE deduction in Year
1.
(i) Allocation of the group's domestic related current year BIE
deduction status. Because each member is deducting $20x of its Year
1 business interest expense, all three members have the same
percentage of current year BIE deduction attributable to them. The
percentage of current year BIE deduction attributable to each of P,
S1, and S2 is 33.33% (each member's current year BIE deduction in
Year 1, $20x, divided by the group's aggregate current year BIE
deduction for Year 1, $60x). Thus, the amount of domestic related
current year BIE deduction status allocable to each member is $12x
(the group's domestic related current year BIE deduction, $36x,
multiplied by the percentage of current year BIE deduction allocable
to each member, 33.33%).
(ii) Allocations of the group's foreign related current year BIE
deduction status. The amount of foreign related current year BIE
deduction status allocable to each member is $8x (the group's
foreign related current year BIE deduction, $24x, multiplied by the
percentage of current year BIE deduction allocable to each member,
33.33%, as computed earlier in paragraph (f)(3) of this section
(Example 3).
(4) Application of the allocation rule in paragraph (c)(5) of
this section. In Year 1 the group has $60x of domestic related
current year BIE, of which $36x is deducted in the year (by
operation of the classification rule). Therefore, the group has $24x
of domestic related BIE carryforward. Similarly, the group has $40x
of foreign related current year BIE in Year 1, of which $24x is
deducted in the year. Therefore, the group has $16x of foreign
related BIE carryforward. The $24x domestic related BIE carryforward
status and $16x foreign related BIE carryforward status will be
allocated to P, S1, and S2 in proportion to the amount of each
member's disallowed BIE carryforward.
(i) Allocation to P. The percentage of disallowed BIE
carryforward allocable to P is 33.33% (P's Year 1 disallowed BIE
carryforward, $40x ($60x - $20x), divided by the group's Year 1
disallowed BIE carryforward, $120x ($60x + $40x + 80x - $60x)).
Thus, the amount of domestic related BIE carryforward status
allocated to P is $8x (the group's domestic related BIE
carryforward, $24x, multiplied by the percentage of disallowed BIE
carryforward allocable to P, 33.33%); and the amount of foreign
related BIE carryforward status allocated to P is $5.33x (the
group's foreign related BIE carryforward, $16x, multiplied by the
percentage of disallowed BIE carryforward allocable to P, 33.33%).
Under paragraph (c)(5)(iv) of this section, P's disallowed BIE
carryforward that has not been allocated a status as either a
domestic related BIE carryforward or a foreign related BIE
carryforward will be treated as interest paid or accrued to an
unrelated party. Therefore, $26.67x ($40x P's disallowed BIE
carryforward -$8x domestic related BIE carryforward status allocated
to P -$5.33x foreign related BIE carryforward status allocated to P)
is treated as interest paid or accrued to an unrelated party.
(ii) Allocation to S1. The percentage of disallowed BIE
carryforward allocable to S1 is 16.67% (S1's Year 1 disallowed BIE
carryforward, $20x ($40x - $20x), divided by the group's Year 1
disallowed BIE carryforward, $120x ($60x + $40x + 80x - $60x). Thus,
the amount of domestic related BIE carryforward status allocated to
S1 is $4x (the group's domestic related BIE carryforward, $24x,
multiplied by the percentage of disallowed BIE carryforward
allocable to S1, 16.67%); and the amount of foreign related BIE
carryforward status allocated to S1 is $2.67x (the group's foreign
related BIE carryforward, $16x, multiplied by the percentage of
disallowed BIE carryforward allocable to S1, 16.67%). Under
paragraph (c)(5)(iv) of this section, S1's disallowed BIE that has
not been allocated a status as either a domestic related BIE
carryforward or a foreign related BIE carryforward will be treated
as interest paid or accrued to an unrelated party. Therefore,
$13.33x ($20x S1's disallowed BIE carryforward -$4x domestic related
BIE carryforward status allocated to S1 - $2.67x foreign related BIE
carryforward status allocated to S1) is treated as interest paid or
accrued to an unrelated party.
(iii) Allocation to S2. The percentage of disallowed BIE
carryforward allocable to S2 is 50% (S2's Year 1 disallowed BIE
carryforward, $60x ($80x - $20x), divided by the group's Year 1
disallowed BIE carryforward, $120x ($60x + $40x + 80x - $60x). Thus,
the amount of domestic related BIE carryforward status allocated to
S2 is $12x (the group's domestic related BIE carryforward, $24x,
multiplied by the percentage of disallowed BIE carryforward
allocable to S2, 50%); and the amount of foreign related BIE
carryforward status allocated to S2 is $8x (the group's foreign
related BIE carryforward, $16x, multiplied by the percentage of
disallowed BIE carryforward allocable to S2, 50%). Under paragraph
(c)(5)(iv) of this section, S2's disallowed BIE that has not been
allocated a status as either a domestic related BIE carryforward or
a foreign related BIE carryforward will be treated as interest paid
or accrued to an unrelated party. Therefore, $40x ($60x S2's
disallowed BIE carryforward -$12x domestic related BIE carryforward
status allocated to S2 - $8x foreign related BIE carryforward status
allocated to S2) is treated as interest paid or accrued to an
unrelated party.
(ii) The group deducting its disallowed BIE carryforwards--(A)
Facts. The facts are the same as in paragraph (g)(3)(i)(A) of this
section (the facts in Example 3(i)), and in addition, none of the
members incurs any business interest expense in Year 2. The group's
section 163(j) limitation for Year 2 is $30x.
(B) Analysis--(1) Application of the absorption rule in
paragraph (c)(2) of this section. Following the rules in section
163(j), each member of the group is deducting $10x of its disallowed
BIE carryforward from Year 1. Therefore, the group's section 163(j)
deduction for Year 2 is $30x.
(2) Application of the classification rule in paragraph (c)(3)
of this section. Under paragraph (c)(3)(iv) of this section, to the
extent members are deducting their Year 1 disallowed BIE
carryforward in Year 2, the classification rule will apply to the
deduction in Year 2 after the allocation rule in paragraph (c)(5) of
this section has allocated the related and unrelated party status to
the member's disallowed BIE carryforward in Year 1. The allocation
required under paragraph (c)(5) of this section is described in
paragraph (f)(3)(i)(B)(4) of this section.
(i) Use of P's allocated domestic related BIE carryforward
status and foreign related BIE carryforward status. P has $40x of
Year 1 disallowed BIE carryforward, and P was allocated $8x of
domestic related BIE carryforward status and $5.33x of foreign
related BIE carryforward status. In Year 2, P deducts $10x of its
Year 1 disallowed BIE carryforward. Under the classification rule of
paragraph (c)(3) of this section, P is treated as deducting pro-rata
from its allocated status
[[Page 67044]]
of domestic related BIE carryforward and foreign related BIE
carryforward. Therefore, P is treated as deducting $6x of its
allocated domestic related BIE carryforward ($10x x $8x/($8x +
$5.33x)), and $4x of its allocated foreign related BIE carryforward
($10x x $5.33x/$8x + $5.33x)). After Year 2, P has remaining $30x of
Year 1 disallowed BIE carryforward, of which $2x has a status of
domestic related BIE carryforward, $1.33x has the status of foreign
related BIE carryforward, and $26.67x of interest treated as paid or
accrued to unrelated parties.
(ii) Use of S1's allocated domestic related BIE carryforward
status and foreign related BIE carryforward status. S1 has $20x of
Year 1 disallowed BIE carryforward, and S1 was allocated $4x of
domestic related BIE carryforward status and $2.67x of foreign
related BIE carryforward status. In Year 2, S2 deducts $10x of its
Year 1 disallowed BIE carryforward. Because S2's deduction of its
Year 1 disallowed BIE carryforward, $10x, exceeds its allocated
domestic related BIE carryforward status ($4x) and foreign related
BIE carryforward status ($2.67x), all of the allocated related party
status are used up. After Year 2, all of S1's Year 1 disallowed BIE
carryforward, $10x, is treated as interest paid or accrued to an
unrelated party.
(iii) Use of S2's allocated domestic related BIE carryforward
status and foreign related BIE carryforward status. S2 has $60x of
Year 1 disallowed BIE carryforward, and S2 was allocated $12x of
domestic related BIE carryforward status and $8x of foreign related
BIE carryforward status. In Year 2, S2 deducts $10x of its Year 1
disallowed BIE carryforward. Under the classification rule of
paragraph (c)(3) of this section, S2 is treated as deducting $6x of
its allocated domestic related BIE carryforward ($10x x $12x/($12x +
$8x)), and $4x of its allocated foreign related BIE carryforward
($10x x $8x/$8x + $12x)). After Year 2, P has remaining $50x of Year
1 disallowed BIE carryforward, of which $6x has a status of domestic
related BIE carryforward, $4x has the status of foreign related BIE
carryforward, and $40x of interest treated as paid or accrued to
unrelated parties.
(h) Applicability date. This section applies to taxable years for
which the original consolidated Federal income tax return is due
(without extensions) after December 6, 2019.
0
Par. 9. Section 1.1502-100 is amended by revising paragraph (b) to read
as follows:
Sec. 1.1502-100 Corporations exempt from tax.
* * * * *
(b) The tax liability for a consolidated return year of an exempt
group is the tax imposed by section 511(a) on the consolidated
unrelated taxable income for the year (determined under paragraph (c)
of this section), and by allowing the credits provided in Sec. 1.1502-
2(b).
* * * * *
0
Par. 10. Section 1.6038A-1 is amended by
0
1. Re-designating paragraph (n)(2) as paragraph (n)(2)(i) and adding a
subject heading for newly re-designated paragraph (n)(2)(i).
0
2. Adding a sentence to the end of newly re-designated paragraph
(n)(2)(i).
0
3. Adding paragraph (n)(2)(ii).
0
4. Revising the last sentence of paragraph (n)(3).
The additions and revision read as follows:
Sec. 1.6038A-1 General requirements and definitions.
* * * * *
(n) * * *
(2) Section 1.6038A-2--(i) In general. * * * Section 1.6038A-
2(a)(3), (b)(6), and (b)(7) apply to taxable years ending on or after
December 17, 2018. However, taxpayers may apply these final regulations
in their entirety for taxable years ending before December 17, 2018.
(ii) Transition rule. No penalty under sections 6038A(d) or
6038C(c) will apply to a failure solely under Sec. 1.6038A-2(a)(3),
(b)(6), or (b)(7) that is corrected by March 6, 2020.
(3) * * * For taxable years ending on or before December 31, 2017,
see Sec. 1.6038A-4 as contained in 26 CFR part 1 revised as of April
1, 2018.
* * * * *
0
Par. 11. Section 1.6038A-2 is amended by
0
1. Revising the subject headings for paragraphs (a) and (a)(1).
0
2. Revising paragraph (a)(2).
0
3. Adding paragraph (a)(3).
0
4. Revising paragraphs (b)(1)(ii), (b)(2)(iv), and the second sentence
of paragraph (b)(3).
0
5. Redesignating paragraphs (b)(6) through (9) as paragraphs (b)(8)
through (11).
0
6. Adding new paragraphs (b)(6) and (7).
0
7. Revising paragraph (c) and the first sentence of paragraph (d).
0
8. Removing the language ``Paragraph (b)(8)'' from the second sentence
of paragraph (g) and adding the language ``Paragraph (b)(10)'' in its
place.
0
9. Adding three sentences to the end of paragraph (g).
The revisions and additions read as follows:
Sec. 1.6038A-2 Requirement of return.
(a) Forms required--(1) Form 5472. * * *
(2) Reportable transaction. A reportable transaction is any
transaction of the types listed in paragraphs (b)(3) and (4) of this
section, and, in the case of a reporting corporation that is an
applicable taxpayer, as defined under Sec. 1.59A-2(b), any other
arrangement that, to prevent avoidance of the purposes of section 59A,
is identified on Form 5472 as a reportable transaction. However, except
as the Secretary may prescribe otherwise for an applicable taxpayer,
the transaction is not a reportable transaction if neither party to the
transaction is a United States person as defined in section 7701(a)(30)
(which, for purposes of section 6038A, includes an entity that is a
reporting corporation as a result of being treated as a corporation
under Sec. 301.7701-2(c)(2)(vi) of this chapter) and the transaction--
(i) Will not generate in any taxable year gross income from sources
within the United States or income effectively connected, or treated as
effectively connected, with the conduct of a trade or business within
the United States, and
(ii) Will not generate in any taxable year any expense, loss, or
other deduction that is allocable or apportionable to such income.
(3) Form 8991. Each reporting corporation that is an applicable
taxpayer, as defined under Sec. 1.59A-2(b), must make an annual
information return on Form 8991. The obligation of an applicable
taxpayer to report on Form 8991 does not depend on applicability of tax
under section 59A or obligation to file Form 5472.
(b) * * *
(1) * * *
(ii) The name, address, and U.S. taxpayer identification number, if
applicable, of all its direct and indirect foreign shareholders (for an
indirect 25-percent foreign shareholder, explain the attribution of
ownership); whether any 25-percent foreign shareholder is a surrogate
foreign corporation under section 7874(a)(2)(B) or a member of an
expanded affiliated group as defined in section 7874(c)(1); each
country in which each 25-percent foreign shareholder files an income
tax return as a resident under the tax laws of that country; the places
where each 25-percent shareholder conducts its business; and the
country or countries of organization, citizenship, and incorporation of
each 25-percent foreign shareholder.
* * * * *
(2) * * *
(iv) The relationship of the reporting corporation to the related
party (including, to the extent the form may prescribe, any
intermediate relationships).
(3) * * * The total amount of such transactions, as well as the
separate amounts for each type of transaction described below, and, to
the extent the form may prescribe, any further
[[Page 67045]]
description, categorization, or listing of transactions within these
types, must be reported on Form 5472, in the manner the form or its
instructions may prescribe. * * *
* * * * *
(6) Compilation of reportable transactions across multiple related
parties. A reporting corporation must, to the extent and in the manner
Form 5472 or its instructions may prescribe, include a schedule
tabulating information with respect to related parties for which the
reporting corporation is required to file Forms 5472. The schedule will
not require information (beyond totaling) that is not required for the
individual Forms 5472. The schedule may include the following:
(i) The identity and status of the related parties;
(ii) The reporting corporation's relationship to the related
parties;
(iii) The reporting corporation's reportable transactions with the
related parties; and
(iv) Other items required to be reported on Form 5472.
(7) Information on Form 5472 and Form 8991 regarding base erosion
payments. If any reporting corporation is an applicable taxpayer, as
defined under Sec. 1.59A-2(b), it must report the information required
by Form 8991 and by any Form 5472 it is required to file (including the
information required by their accompanying instructions), regarding:
(i) Determination of whether a taxpayer is an applicable taxpayer;
(ii) Computation of base erosion minimum tax amount, including
computation of regular tax liability as adjusted for purposes of
computing base erosion minimum tax amount;
(iii) Computation of modified taxable income;
(iv) Base erosion tax benefits;
(v) Base erosion percentage calculation;
(vi) Base erosion payments;
(vii) Amounts with respect to services as described in Sec. 1.59A-
3(b)(3)(i), including a breakdown of the amount of the total services
cost and any mark-up component;
(viii) Arrangements or transactions described in Sec. 1.59A-9;
(ix) Any qualified derivative payment, including:
(A) The aggregate amount of qualified derivative payments for the
taxable year; and
(B) A representation that all payments satisfy the requirements of
Sec. 1.59A-6(b)(2); and
(x) Any other information necessary to carry out section 59A.
* * * * *
(c) Method of reporting. All statements required on or with the
Form 5472 or Form 8991 under this section and Sec. 1.6038A-5 must be
in the English language. All amounts required to be reported under
paragraph (b) of this section must be expressed in United States
currency, with a statement of the exchange rates used, and, to the
extent the forms may require, must indicate the method by which the
amount of a reportable transaction or item was determined.
(d) * * * A Form 5472 and Form 8991 required under this section
must be filed with the reporting corporation's income tax return for
the taxable year by the due date (including extensions) of that return.
* * *
* * * * *
(g) * * * Paragraph (b)(7)(ix) of this section applies to taxable
years beginning June 7, 2021. Before these final regulations are
applicable, a taxpayer will be treated as satisfying the reporting
requirement described in Sec. 1.59A-6(b)(2) only to the extent that it
reports the aggregate amount of qualified derivative payments on Form
8991. See Sec. 1.59A-6(b)(2)(iv) (transition period for qualified
derivative payment reporting).
Sec. 1.6038A-4 [Amended]
0
Par. 12. For each paragraph listed in the table, remove the language in
the ``Remove'' column from wherever it appears and add in its place the
language in the ``Add'' column as set forth below and in paragraph (f),
designate Examples 1 and 2 as paragraphs (f)(1) and (2), respectively.
------------------------------------------------------------------------
Paragraph Remove Add
------------------------------------------------------------------------
(a)(1).............................................. $10,000 $25,000
(a)(3).............................................. 10,000 25,000
(d)(1).............................................. 10,000 25,000
(d)(4).............................................. 10,000 25,000
(f)................................................. 10,000 25,000
(f)................................................. 30,000 75,000
(f)................................................. 90,000 225,000
------------------------------------------------------------------------
Sec. 1.6655-5 [Amended]
0
Par. 13. Section 1.6655-5 is amended in paragraph (e) by designating
Examples 1 through 13 as paragraphs (e)(1) through (13), respectively,
and by removing the language ``Sec. 1.1502-2(h)'' in newly designated
paragraph (e)(10) and adding the language ``Sec. 1.1502-1(h)'' in its
place.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: November 13, 2019.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-25744 Filed 12-2-19; 4:15 pm]
BILLING CODE 4830-01-P