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Group Raises Concerns About Base Erosion and Antiabuse Tax

APR. 2, 2018

Group Raises Concerns About Base Erosion and Antiabuse Tax

DATED APR. 2, 2018
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Request for Guidance on Issues Arising under New Section 59A

Alliance for Competitive Taxation

April 2, 2018


Contents

I. Introduction

II. Description of section 59A issues

III. ACT member companies


I. Introduction

The Alliance for Competitive Taxation (“ACT”) is a coalition of leading American companies from a wide range of industries that supports a globally competitive U.S. corporate tax system that aligns the United States with other advanced economies. A list of ACT member companies is included in Section III of this submission.

Recognizing that issuance of guidance under new section 59A is listed in the 2017-18 Priority Guidance Plan released on February 7, 2018, ACT has identified a number of issues for which guidance is requested.

This submission describes the section 59A issues that ACT has identified and includes a discussion of considerations that should be taken into account in promulgating guidance. In a subsequent submission, ACT will provide recommendations as to how Treasury and the IRS should address these issues.

Please contact Alan Fischl at (202) 414-1030 or alan.l.fischl@pwc.com if you have any questions regarding this submission.

II. Description of BEAT issues

List of issues

1) Aggregation rule and intragroup payments

2) Scope of “paid or accrued”

3) Payments involving partnerships

4) Branches

5) Consolidated groups

6) Foreign currency transactions

7) Qualified derivative payments

8) Section 15

9) Cost sharing/reimbursements in general

10) Netting

11) Bundled transactions

12) Service cost method exception

13) Insurance issues

14) Unintended consequences

1. Aggregation rule and intragroup payments

Issues:

  • Aggregation rule: for purposes of determining (1) the base erosion percentage and (2) the gross receipts threshold with respect to the definition of an “applicable taxpayer” members of a controlled group within the meaning of section 1563 (as modified) are treated as a single taxpayer. See section 59A(e)(3). Section 59A also provides special rules for foreign corporations.

    • Are payments between members of the controlled group disregarded for purposes of determining the base erosion percentage?

    • Are payments between members of the controlled group disregarded for purposes of determining the gross receipts threshold under the applicable taxpayer test?

    • Are payments between members of the same U.S. tax consolidated group includible in the denominator of the base erosion percentage? A deduction is not eliminated in consolidation.

2. Scope of “paid or accrued”

Background:

  • Section 59A(d)(2), which relates to the purchase of depreciable property, expands the definition of a “base erosion payment” to include “any amount paid or accrued by the taxpayer to a foreign person which is a related party of the taxpayer in connection with the acquisition by the taxpayer from such person of property of a character subject to the allowance of depreciation (or amortization in lieu of depreciation).”

Issues:

  • What is the scope of the definition of “paid or accrued” by a taxpayer in the context of an acquisition of property?

    • Specifically, in the context of an acquisition of property of a type that is depreciable/amortizable in an inbound section 351 contribution, section 332 liquidation, or F reorganization transaction, would the acquisition of such property be considered a base erosion payment?

    • In a distribution of appreciated (and depreciable) property subject to section 311(b), which requires gain to be recognized by the distributing party as if “such property were sold to the distributee at its fair market value,” would the fair market value of the property be treated as an amount “paid or accrued” by the distributee so that such amount is a base erosion payment?

    • Could “any amount paid or accrued” be broad enough to include any transfer of value in exchange for property (e.g., deemed exchanges)?

    • Does “any amount paid or accrued” include amounts paid with the acquiror's stock?

3. Payments involving partnerships

Issue 1:

  • Is a payment made by a domestic partnership with domestic corporate partners subject to BEAT? Would the answer be different for a foreign partnership?

Considerations:

  • The term “base erosion payment” means 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 allowable under this chapter. Section 59A(d)(1).

  • Section 59A(e)(1)(A) defines “applicable taxpayer” as “a corporation” only.

  • Under Treas. Reg. § 1.702-1(a)(8)(ii), a partner must take into account separately its distributive share of any partnership item which, if separately taken into account by the partner, would result in an income tax liability different from that which would result if that partner did not take the item into account separately.

  • Pursuant to section 702(b) and Treas. Reg. § 1.702-1(b), the character of the distributive share in the hands of the partner is determined as if it were realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership.

Issue 2:

  • Is a payment made to a domestic partnership with foreign corporate partners subject to BEAT?

Considerations:

  • The term “base erosion payment” means 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 allowable under this chapter. Section 59A(d)(1).

  • Under section 7701(a)(30) a U.S. person includes a domestic partnership.

  • Section 59A's definitions of “related party” (see section 59A(g)) and “foreign person” (see section 59A(f)) include partnerships.

  • Given these definitions, should partnerships be treated as entities or aggregates for purposes of testing base erosion payments received by the partnership?

Issue 3:

  • Is a payment made to a foreign partnership with domestic corporate partners subject to BEAT?

Considerations:

  • The term “base erosion payment” means 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 allowable under this chapter. Section 59A(d)(1).

  • The definition of a U.S. person under section 7701(a)(30) does not include a foreign partnership.

  • Section 59A's definitions of “related party” (see section 59A(g)) and “foreign person” (see section 59A(f)) include partnerships.

  • Given these definitions, should partnerships be treated as entities or aggregates for purposes of testing base erosion payments?

  • Does the interposition of a partnership affect the applicability of BEAT?

  • Should an aggregate or entity approach apply for purposes of payments made to or from a partnership? Should the approaches be the same for payments to and from a partnership?

  • Treas. Reg. § 1.701-2(e): “The Commissioner can treat a partnership as an aggregate of its partners in whole or in part as appropriate to carry out the purpose of any provision of the Internal Revenue Code or the regulations promulgated thereunder.”

    • Exception for clearly contemplated entity treatment under a particular Code provision or regulations thereunder.

4. Branches

Issue:

  • Whether a deductible payment made to a U.S. branch of a foreign corporation that is treated as income effectively connected with the foreign corporation's U.S. trade or business (“ECI”) should be subject to BEAT?

Considerations:

  • To the extent the payment is treated as income effectively connected with Foreign Co's U.S. trade or business the payment is not eroding the U.S. tax base. Further, the Foreign Co may be subject to a branch profits tax that would not be includible in its regular tax liability for purposes of section 59A.

  • Under the BEAT there is no rule that treats a U.S. branch as a U.S. person.

5. Consolidated groups

Issue:

  • Is the BEAT calculation performed at the consolidated filer level or an entity-by-entity basis?

Considerations:

  • The statute does not explicitly provide that BEAT applies on a consolidated group basis. However, Treasury would seem to have regulatory authority to provide this treatment.

  • With respect to a consolidated group, “regular tax liability” under section 26 generally means the consolidated group liability. See Treas. Reg. §§ 1.1502-2, -11.

  • Treasury has indicated its intent to apply section 163(j) on a consolidated group basis. Given the interactions between sections 163(j) and 59A, query whether the two sections should operate similarly with respect to consolidated group treatment.

  • There is also case law that argues a provision is not applied on a consolidated group basis unless the statute expressly provides so. See First Chicago Corp. v. Commissioner, 96 T.C. 421 (1991).

  • To the extent the Treasury and IRS provide that BEAT applies at a consolidated level, consider the following scenario:

    • U.S. consolidated group A (“Group A”) has a taxable year beginning December 1, 2017. U.S. consolidated group B (“Group B”) has a taxable year beginning January 1, 2018. Thus, Group A is not subject to BEAT until December 1, 2018, while Group B became subject to BEAT on January 1, 2018.

    • If Group A acquires Group B on May 1, 2018, and the two merge into a single U.S. consolidated group:

      • Are outbound payments by Group A members “tainted” so that they would become subject to BEAT on May 1, 2018? If so, is the BEAT exposure only to the extent of base eroding payments made by Group B?

        • The same issue may arise when Group A acquires any corporation with a taxable year subject to BEAT.

      • Are the gross receipts of the two groups aggregated for purposes of determining whether a member is an applicable taxpayer?

  • U.S. consolidated groups are required to compute NOLs on a consolidated basis. See United Dominion Industries, Inc. v. United States, 532 U.S. 822 (2001).

6. Foreign currency transactions

Background:

  • The term “base erosion payment” generally means “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 allowable under this chapter.” Section 59A(d)(1).

    • A deduction is allowed with respect to a foreign currency (“FX”) loss under section 165.

Issues:

  • Does the definition of a base erosion payment require the entire amount of the payment to be deductible (e.g., in the case of an interest payment)?

  • Or do the references to “any amount paid or accrued” and “with respect to which a deduction is allowable” suggest that the statute could apply more broadly to cause a portion of the payment that represents a deductible loss to be a base erosion payment?

  • As such, should FX losses embedded in payments made pursuant to certain FX transactions be treated as base erosion payments (see examples that follow)?

Examples:

  • Example 1 — intercompany lending: FCo, a foreign corporation, is related to US Co, a domestic corporation. FCo's functional currency is the EUR and US Co's functional currency is the USD. In year 1, when the EUR/USD exchange rate is 1:1, FCo lends US Co EUR 100. The loan bears annual interest and matures in year 5. USD depreciated against the EUR over the term of the loan such that US Co incurs FX losses on each interest payment. In year 5, when the EUR/USD exchange rate is 1:1.2, US Co repays the loan, incurring a $20 FX loss on repayment.

    • Are US Co's FX losses with respect to the interest and principal payments “base erosion payments”? Similar questions may arise with respect to foreign currency swaps between a U.S. corporation and a related foreign person.

  • Example 2 — FX derivative: Treasury Center (“TC”) is a foreign corporation that has a EUR functional currency. US Co is a domestic corporation related to TC that has a USD functional currency. In year 1, US Co executes a FX forward contract with TC to hedge its FX exposure. Pursuant to the forward contract, US Co will purchase EUR 100 from TC at a 1:1.2 EUR/USD exchange rate in year 2. In year 2, when the EUR/USD exchange rate is 1:1, US Co settles the forward at a $20 FX loss.

    • Assuming that the qualified derivative payment exception under section 59A(h) does not apply (e.g., because U.S. Co does not mark to market the forward contract), is US Co's FX loss with respect to the settlement of the forward contract a “base erosion payment”? Does it matter if the parties “cash” or physically settle the forward contract (see next slide)?

Considerations:

  • In order to be a “base erosion payment,” section 59A(d)(1) requires that such amount be paid or accrued. In the preceding examples, are the FX losses “paid or accrued” to the related party? Or do the FX losses arise as a result of the payment?

    • The deduction of an FX loss involves the comparison of the amounts paid in the taxpayer's functional currency translated from the nonfunctional currency amount at different exchange rates (see e.g., Treas. Reg. § 1.988-2(b)(6) (relating to exchange gain/loss recognized by the obligor of a debt instrument with respect to principal)), whereas a deductible expense is simply deducted in the amount of such expense.

    • Should an FX loss be viewed as part of the amount paid or accrued? Or is it a result that is separate from the amount paid or accrued?

  • In Example 2, if US Co “cash settles” the forward contract (i.e., US Co pays TC $20, rather than USD 120 in exchange for EUR 100), such payment equals US Co's $20 FX loss.

    • In such a scenario, the payment is in the amount of the deductible FX loss. Is a cash settlement payment a base erosion payment?

    • Should the form of the settlement (cash v. physical) transaction lead to different treatment for BEAT?

7. Qualified derivative payments

Issues:

  • Reporting requirements:

    • Section 59A(h)(2)(B) provides that a payment that otherwise meets the requirements to be treated as a qualified derivative payment must be properly reported under section 6038B(b)(2). The cross reference to section 6038B(b)(2) is incorrect and should be section 6038A(b)(2).

    • Will any reporting will be required if the statute is not corrected?

    • Assuming the cross-reference is corrected, will guidance clarify the scope and extent of reporting that would be required under section 6038A(b)(2)?

8. Section 15

Background:

  • BEAT applies to base erosion payments paid or accrued in tax years beginning after December 31, 2017. Thus, payments made in a fiscal year beginning in 2017 and ending in 2018 would not be subject to BEAT. Payments made in a fiscal year beginning in 2018 and ending in 2019 could be subject to BEAT.

  • The percentage of a taxpayer's modified taxable income that is subject to BEAT is: (1) 5 percent for taxable year beginning in the 2018 calendar year; (2) 10 percent for taxable year beginning after December 31, 2018; and (3) 12.5 percent for taxable years beginning after December 31, 2025.

  • Section 15(a) provides for the computation of tax using a blended tax rate when the statutory tax rate changes in the middle of a fiscal tax year. In this case:

    • tentative taxes shall be computed by applying the rate for the period before the effective date of the change, and the rate for the period on and after such date, to the taxable income for the entire taxable year; and

    • the tax for such taxable year shall be the sum of that proportion of each tentative tax which the number of days in each period bears to the number of days in the entire taxable year.

  • Section 15 is silent on the imposition of a new tax. However, Treas. Reg. § 1.15-1(d) provides that section 15 does not apply to the imposition of a new tax.

Issue:

  • Does section 15 apply to BEAT?

Example:

  • USCo has a fiscal taxable year that ends June 30, 2018. Outbound payments that constitute base erosion payments made by USCo during its taxable year beginning July 1, 2018 and ending June 30, 2019 would be subject to BEAT.

  • As mentioned, the percentage of a taxpayer's modified taxable income that is subject to BEAT is: (1) 5 percent for taxable year beginning in the 2018 calendar year; (2) 10 percent for taxable year beginning after December 31, 2018

  • Does section 15 apply so that USCo should use a blended tax rate in computing its BEAT tax? If so, pursuant to section 15(a), the following would result:

    (50% of days in 2018 * 5% applicable rate) + (50% of days in 2019 * 10% applicable rate) = 7.5%, blended BEAT rate for the year.

9. Cost sharing/reimbursements in general

Issues:

  • Are cost sharing payments made to a foreign related party base erosion payments?

  • Are reimbursement payments made to a foreign related party base erosion payments?

Considerations:

  • Treas. Reg. § 1.482-7(j)(3)(i) provides that cost sharing payments are treated as the payor's cost of development and reduce the payee's development costs. Does this regulatory treatment affect whether the cost sharing payment is a base erosion payment?

  • Should other (non-cost sharing) reimbursement payments made to a foreign related party payee be subject to BEAT or should the reimbursed cost be looked through as if the payor had incurred the expense directly to determine whether the payment should be subject to BEAT? For example, if a US company pays a foreign related company to reimburse the salaries/benefits paid to employees seconded to the US company should those payments be treated as base erosion payments? Does it matter whether the reimbursement doctrine applies (i.e., the payee has no income from the receipt of the reimbursement from the payor and is not allowed a deduction with respect to the reimbursed costs) because the reimbursement payment is in the nature of a repayment of an advance for the payor's benefit?

  • What if the foreign related party is receiving other non-cost sharing payments/funds as an agent of the payor, not as the recipient of a reimbursement payment? Would it be appropriate in this case to look through the agent and to treat the payment as an amount received and handled by the foreign related party solely in its capacity as an agent and not as the payee of the payment?

10. Netting

Issues:

  • When a U.S. party both receives and provides services (or cross-licenses IP rights) from/to its foreign affiliates, and the parties make only a single net balancing payment between them, is only the net payment recognized when determining base erosion payment amounts? Or must gross cross-payments be recognized?

    • Example 1: US Co has a cross-license with a foreign affiliate, and receives a single net royalty payment from the affiliate. Should the net cross-license payment be unbundled and a gross royalty payment to the foreign affiliate recognized for BEAT purposes?

    • Example 2: US Co acts as a clearinghouse for intercompany charges between foreign affiliates. Foreign Affiliate A charges US Co for services and US Co in turn re-charges the service fee to Foreign Affiliate B. Does the service charge paid to Foreign Affiliate A constitute a base erosion payment?

Considerations:

  • Under general tax principles, gross amounts not net amounts are recognized (e.g., in cross-licenses or cross-service arrangements).

  • In Example 2, does the answer depend on whether US Co is acting as a prime contractor and paying the foreign affiliate as a subcontractor? What if the reimbursement doctrine applies because US Co is contractually entitled to reimbursement of the outbound payment? What if US Co is acting only as an agent in receiving and remitting funds between the foreign affiliates?

11. Bundled transactions

Issues:

  • Bundled transactions: Many intercompany arrangements involve multiple elements that are benchmarked in the aggregate under the selected transfer pricing method.

    • For example, a franchise arrangement where a U.S. company pays for a combination of services, royalties and tangible goods purchases and the transfer pricing method evaluates all the transactions in the aggregate, and not individually, by testing only the overall profitability of the U.S. company.

    • For example, a U.S. company engages in multiple transactions involving related party provision of services and goods and the transfer pricing method applies a single aggregate profitability test (because the transactions are interrelated or it is simpler).

  • How should it be determined whether and to what extent payments made to foreign related parties in such bundled transactions are base erosion payments?

Considerations:

  • In general, the way the transaction is structured by the parties determines the character of the payments for U.S. income tax purposes, unless the structure lacks economic substance.

  • When would it be appropriate to “ unbundle” and separately evaluate the consideration paid in these transactions for BEAT purposes? Assuming unbundling is appropriate in a particular case, what principles should be applied to determine the amount and character of the separate payments for BEAT purposes?

12. Service cost method exception

Issues:

  • Section 59A(d)(5) provides that if a payment is eligible for the services cost method (“SCM”) under Treas. Reg. § 1.482-9(b) and “such amount constitutes the total services cost with no markup component,” the payment is not a base erosion payment.

  • Where the total amount paid for an eligible service includes a markup, is the cost component excludable under this SCM exception? What if two payments are made, i.e., one for the cost of the eligible service and one for the markup? Should taxpayers be required to modify their systems to create separate payment accounts even though this would not affect the substance of the payments?

  • Does the SCM actually have to be elected, or is mere eligibility for the SCM election all that is required?

Considerations:

  • Statutory text supports exclusion of the cost component of marked up payments.

  • Colloquy between Senator Portman and Chairman Hatch on Senate bill supports exclusion of the cost component of marked up payments, at least where the taxpayer has separate payment accounts for each component.

  • Conference report explanation seems to suggest cost component of marked up payments is not excluded, although language is unclear.

Example

USP pays $107 for services, representing cost + 7% markup.

Total $107 service charge consists of:

(i) a cost component of $100 (CFC's total services costs);

(ii) a markup component of $7.

If the services otherwise qualify for the SCM exception, then under the approach in the colloquy the base erosion payment would equal only $7 and would exclude the $100 cost component.

Under the alternative approach, the entire $107 payment would be a base erosion payment, even if the services otherwise qualify for the SCM exception.

13. Insurance issues

Issues:

1. How is the 3-percent base erosion percentage computed for a U.S. insurance company?

  • Are amounts that arise out of insurance or reinsurance, such as losses and ceding commissions, treated as deductible payments or as reductions in gross premiums as provided under subchapter L?

  • It appears that reinsurance premiums paid to an unrelated (U.S. or foreign) party are not included in the denominator when computing the base erosion percentage because such amounts are not deductions under subchapter L, but reductions to gross income. Is this correct? (Reinsurance premiums paid to a foreign related party are treated as base erosion payments and included in both the numerator and denominator for purposes of computing the base erosion percentage of the taxpayer.)

2. If a U.S. insurance company reinsures risks of a foreign affiliate, are loss payments and ceding commissions paid to the foreign affiliate treated as deductions and therefore base erosion payments, or are they treated as reductions in gross income as under subchapter L? If these payments are treated as deductions and therefore base erosion payments, is the U.S. company penalized for bringing reinsurance business into the United States?

3. If a U.S. insurance company establishes and deducts loss reserves in 2017, and pays the underlying claims in 2018, is the base erosion payment the 2017 establishment of the loss reserve or the 2018 claim payment? (The insurance company may not know until 2018 whether the claim will be paid to a foreign related party.)

4. How are gross receipts measured for an insurance company? For example, are premiums accounted for gross or net of reinsurance premiums paid? Are they accounted for on a written or earned basis? Are gains/losses on sale of assets (primarily investments) accounted for on a net basis?

5. What is the appropriate treatment for payments to a foreign affiliate arising from business that was previously reinsured and is novated or recaptured from a foreign affiliate? If amounts are simply eliminated for statutory accounting purposes, is this also the correct treatment for purposes of the BEAT?

14. Unintended consequences

  • Payments that do not erode the U.S. tax base. To the extent a deductible payment is currently included in U.S. income either at the foreign payee level as effectively connected income or at the level of the foreign payee's U.S. shareholder (e.g., through GILTI or subpart F), is subjecting such a payment to BEAT appropriate in light of the legislative purpose of BEAT to prevent base erosion?

    • Example: A deductible payment made by a U.S. corporation to the U.S. branch of a foreign related corporation that is treated as income effectively connected with the foreign corporation's U.S. trade or business does not erode the U.S. tax base.

  • No allowance for foreign tax credits. BEAT is imposed to the extent 10 percent (5 percent in 2018) of modified taxable income exceeds a taxpayer's regular U.S. tax liability (adjusted for certain credits). Modified taxable income includes certain types of foreign income, such as GILTI, subpart F, and foreign branch income. For regular tax purposes foreign tax credits are allowed for foreign taxes paid with respect to such income. However, the BEAT effectively taxes such foreign income (whether or not arising from base eroding payments) but allows no credit or deduction for related foreign taxes.

III. ACT member companies

3M

Abbott Laboratories

Alcoa Corporation

Bank of America Corp.

Boston Scientific Corp.

Caterpillar Inc.

The Coca-Cola Company

Danaher Corporation

The Dow Chemical Company

DuPont

Eli Lilly and Company

Emerson Electric Co.

Exxon Mobil Corporation

General Electric Company

General Mills Inc.

Google, Inc.

Honeywell International Inc.

IBM Corporation

International Paper Company

Johnson & Johnson

Johnson Controls, Inc.

JPMorgan Chase & Co.

Kellogg Company

Kimberly-Clark Corp.

MasterCard Inc.

McCormick & Company, Inc.

Morgan Stanley

Oracle Corporation

PepsiCo, Inc.

Procter & Gamble Co.

Prudential Financial Inc.

S&P Global Inc.

State Street Corporation

Texas Instruments, Inc.

United Technologies Corp.

United Parcel Service, Inc.

Verizon Communications Inc.

The Walt Disney Company

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