BEAT Could Eat into Income Tax Savings

Tax legislation generally includes promises to simplify the process of computing taxes. But in the process of transforming legislation into law, those good intentions often are overshadowed by new complexities.

The Tax Cuts and Jobs Act of 2017 is no exception, especially for U.S. multinational corporations. Although most corporations herald their much lower 21% tax rate under the TCJA, it comes with a price.

The law’s Base Erosion Anti-Abuse Tax (BEAT) is designed to discourage companies from steering revenue to lower-tax countries overseas by reducing the incentive to shift profits to foreign-related parties.

Previously, corporations shipped $300 billion of profits annually to lower-tax countries. The Congressional Budget Office estimates that BEAT and other measures will instead add $65 million annually to the federal government’s coffers.

BEAT’s intricacies, of which there are many, haven’t been sorted out entirely, because the IRS has yet to issue final guidelines. But corporations with more than $500 million in U.S.-sourced revenue who make deductible payments to foreign-related entities are vulnerable. It amounts to an alternative minimum tax (AMT).

The BEAT calculation itself is fairly straightforward. It’s computed from Modified Taxable Income (MTI), which equals the corporation’s regular taxable income, with certain foreign-related payments added back.

The BEAT is the excess of 10% of MTI over the company’s regular liability, minus certain tax credits. (There will be an initial 5% phase-in rate for the 2018 tax year, then the 10% will apply through 2025, after which it will rise to 12.5%.) Like-kind payments may be aggregated in the calculation.

As befits tax legislation, details related to the BEAT calculation are more complex.

To begin, corporations must have U.S.-generated revenue of $500 million for the prior three years, subject to some deductions. Unlike the repealed AMT regime, there is no future credit for any BEAT that the taxpayer incurs. Thus, it is a lost cost.

BEAT affects both U.S. and non-U.S. corporations (controlled and consolidated groups), except for regulated investment company (RIC), REIT, and S corporations. The “foreign” entity criterion is satisfied by determining ownership of at least 25% of the taxpayer’s stock and/or other tests to determine relationship or control.

Banks will not receive the benefits of the historic rehabilitation tax credit and the new markets tax credits, and their rate is 1% higher; rates for registered securities dealers and affiliates can be 2% to 3%. BEAT may be considered an additional tax in determining a bank’s effective tax rate, which could reduce regulatory capital. And there is no netting of BEAT payments.

But calculating payments is more involved. Accruals of interest, rents, royalties, trademarks, and certain fees for services are included (though it’s unclear whether deemed/allocated interest expense for foreign banks under Treasury regulations Section 1.882-5 will be considered a BEAT payment).

Payments made in the ordinary conduct of business are excluded, such as cost of goods sold (COGS) and labor, plus qualifying derivative instruments, and other eligible service payments. (This should be addressed specifically in the proposed regulations due out for comment later this year; check IRS website for schedule dates.)

Although BEAT applies to foreign corporations with effectively connected income (ECI), it does not appear to exempt payments to foreign-related entities that treat such payments as ECI. Also, low taxable income due to net operating losses or large credits against regular tax may trigger BEAT.