FedEx Requests Guidance to Clarify BEAT Definitions, Mechanics

July 20, 2018

Mr. Lafayette G. “Chip” Harter III
Deputy Assistant Secretary
International Tax Affairs
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Mr. David J. Kautter
Assistant Secretary for Tax Policy, and Acting Commissioner of the Internal Revenue Service
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Mr. William M. Paul
Acting Chief Counsel and Deputy
Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re: Request for Guidance on Application of Base Erosion and Anti-Abuse Tax

Dear Sirs:

The 2017 Tax Cuts and Jobs Act (the TCJA) added section 59A, commonly referred to as the Base Erosion and Anti-Abuse Tax (the BEAT), to the Internal Revenue Code. Because this provision introduces a completely new Code section, significant ambiguity exists around its definitions and mechanics. Taxpayers urgently need guidance to help them understand how to apply the new concepts introduced in, and to ensure the administrability of, the new provision.

Section 59A(i) allows the Secretary to provide regulations or guidance in order to carry out the provisions of the section. Given this broad legislative authority, FedEx suggests that the Treasury Department and Internal Revenue Service have the regulatory authority to issue guidance that adopts the recommendations made in this letter. Therefore, we respectfully ask that you consider the following recommendations:

• Clarify the application of the services cost method (SCM) exception described in section 59A(d)(5) by providing that the SCM exception applies:

  • regardless of whether the services constitute a fundamental element of a taxpayer's core business;

  • to the cost component of the services charge regardless of whether the service charge also includes a markup component; and

  • regardless of whether the taxpayer maintains formal, separate accounts for the portion of the service charge that represents the cost and the portion of the service charge that represents a markup.

• Provide that the character of payments made to a partnership for BEAT purposes is determined based on an aggregate approach.

• Provide that payments otherwise subject to U.S. federal income tax are not base erosion payments and are exempted from BEAT.

• Provide that taxpayers will not be subject to penalties for late payments or underpayments of tax made for taxable years beginning on or before December 31, 2018, resulting from the new BEAT regime.

We have attached as Appendix A potential regulatory language for these recommendations.

I. Executive Summary

The key points made in this letter may be summarized as follows:

• Section 59A should be interpreted and applied to avoid consequences that are inconsistent with the policy goals of the BEAT provision and the TCJA.

• Section 59A and its legislative history clearly show Congress' intent that the SCM exception should broadly apply to amounts paid for eligible services, whether or not the services constitute a fundamental element of a taxpayer's core business.

• Section 59A and its legislative history also show Congress' intent that the SCM exception apply to the cost component of eligible service charges that also contain a markup component. Such an approach would recognize that service charges paid to foreign related parties often include a profit element to comply with the arm's-length standard under applicable transfer pricing rules.

• Requiring taxpayers to keep formal accounts that separate service charges between the component representing the cost of services and the markup component would be redundant, needlessly burdensome, and unnecessary.

• An aggregate approach should apply to determine the character of payments made to foreign partnerships for BEAT purposes, because an application of the entity view of partnerships in this circumstance would lead to unintended and perverse consequences. In particular, an entity view of partnership under the BEAT provision will impose double taxation on payments (or a portion thereof) made to foreign partnerships that have a U.S. partner.

• Consistent with the policy goal and design of section 59A, payments made by a U.S. corporation that are otherwise subject to U.S. federal income tax should not be treated as base erosion payments. This approach will avoid the double taxation of significant payments made to foreign related parties and the concomitant negative impact on the competitiveness of U.S. corporations.

• Given the novelty of the provision and the lack of current guidance on BEAT, taxpayers should be provided first-year relief from any penalties associated with late payments or underpayments of U.S. tax related to the application of this provision.

II. Description of Relevant Rules

Section 59A(a) imposes a base erosion minimum tax amount (the BEAT Amount) on each applicable taxpayer in a given taxable year. The BEAT Amount equals the excess (if any) of (1) an amount equal to 10 percent¹ of the modified taxable income of the taxpayer for the year, over (2) an amount equal to the regular tax liability (as defined in section 26(b)) of the taxpayer for the taxable year with the regular tax liability reduced (but not below zero) by certain credits.²

Modified taxable income (MTI) means the taxable income of a taxpayer without regard to any base erosion tax benefits that arise from base erosion payments and the base erosion percentage of any net operating loss allowed under section 172 for the taxable year.³

In turn, base erosion payments represent amounts paid or accrued by a taxpayer to a related foreign person (1) for which a deduction is allowable under chapter 1 of the Code, (2) for acquiring property subject to depreciation or amortization, (3) for certain reinsurance payments, or (4) that results in a reduction to gross receipts of the taxpayer, and the related foreign person is a surrogate foreign corporation (as defined in section 59A(d)(4)(C)(i)) or is a member of the same expanded affiliated group (as defined in section 59A(d)(4)(C)(ii)) as the surrogate foreign corporation.

III. Globally-Integrated Service Business and Potential Impact of BEAT

The TCJA was enacted in part to protect the U.S. tax base and discourage deductions by U.S. taxpayers of certain payments made to foreign companies. In particular, Section 59A aims to limit base eroding payments made by:⁴

• Foreign-owned U.S. subsidiaries that make deductible payments to a foreign parent or foreign affiliates that are subject to little or no U.S. withholding tax;

• U.S. subsidiaries of foreign headquartered companies that have an advantage over U.S. headquartered companies and that favor foreign ownership of assets; and

• U.S. and foreign corporations outsourcing their U.S. business operations to foreign jurisdictions at the expense of the American worker.

In addition to preserving the U.S. tax base, section 59A is intended to aid the larger policy goals of the TCJA. These overarching goals of the TCJA range from addressing the competitive disadvantage faced by U.S. multinationals (relative to foreign headquartered firms) with regard to asset ownership under the pre-TCJA tax code and to address U.S. and foreign corporations outsourcing of their U.S. business operations to foreign jurisdictions. Section 59A aims to level the playing field between U.S. and foreign-owned multinational corporations in an administrable way, and purports to achieve these goals by imposing a “minimum tax” on applicable taxpayers that are viewed as overly eroding the U.S. tax base through certain foreign related party payments.⁵ Moreover, a stated objective of the provision is to encourage economically efficient foreign direct investment in the United States.⁶

The recommendations contained in this letter are intended to be respectful of the intended objectives of the TCJA in general, and of Section 59A in particular, while limiting the unintended consequences of the BEAT provision, and rendering it more administratively manageable for both taxpayers and the IRS.

Given the globally integrated nature of many U.S. multinational service companies, certain aspects of the BEAT provision significantly disadvantage U.S. headquartered companies relative to foreign headquartered ones (which may have more flexibility in their operating models to mitigate the impact of BEAT). Guidance should clearly exclude from the BEAT payments made by U.S. entities to foreign entities those payments that are not intended to artificially erode the U.S. tax base, but are unavoidable given the nature of a U.S. multinational's business. Without the guidance discussed below, the application of the BEAT provision may undermine rather than further the goals of the TCJA, and may in fact punish U.S. multinationals and place them at a competitive disadvantage.

FedEx is a U.S.-headquartered corporation engaged in a globally integrated package delivery business. An integral part of our business model is the delivery of packages to locations in foreign countries. FedEx's business thus requires it to employ entities operating and performing physical delivery services in foreign countries which, in turn, requires substantial staffing and significant investment in foreign assets and facilities. Many U.S. multinational companies have similar integrated business operations involving customers purchasing a bundle of services, only some of which are (or can be) performed in the United States. In many instances, the customer makes a combined payment to the U.S. entity, which in turn remits payment to foreign related parties for the portion of services that necessarily occur outside the United States. Such payments are necessary to compensate foreign affiliates for executing their roles in the U.S. multinational's global integrated business model, and must comply with the arm's-length standard under section 482 and the corresponding provisions of foreign law.

Consider a multinational integrated service provider that consists of a U.S. corporation and a foreign related entity responsible for providing transportation and warehousing services in various foreign countries. A U.S. customer purchases a bundle of services that must be partly performed in the United States and partly in a foreign country (e.g., a package shipped from the United States to a foreign country must have the delivery service performed in that foreign country), and makes a combined payment to the U.S. corporation (USC). Assume the combined arm's-length price charged to the customer for both the U.S. and foreign performed services is $100, that USC incurs $40 of direct costs, and that the arm's-length price for the services performed by the foreign entity (CFC) is $55.

USC's profit from the transaction is $5. Treating the $55 payment to CFC as a non-base eroding payment (given that it is the price paid by the customer for the services performed by CFC), USC pays 21 percent tax on its $5 profit, and earns $3.95 of after-tax income. However, if the $55 payment to CFC is considered a base erosion payment under section 59A, USC would have a modified taxable income of $60 for the transaction (taxable income of $5 plus the $55 related party payment). The BEAT amount would be $4.95 (the excess of 10 percent for 2019 of USC's MTI of six dollars over its regular tax liability of $1.05). When combined with a regular tax liability of $1.05, the effective tax rate is 120 percent and turns a pre-tax profit of $5 into an after-tax loss of $1 every time this transaction occurs.

Section 59A clearly would put a globally integrated U.S. multinational at a disadvantage as compared to:

• a non-globally integrated service provider that would purchase the same foreign-based services from a non-related entity, thus making the same $55 paid to the unrelated company a non-base eroding payment, and

• a foreign globally integrated service provider that books $100 in customer revenue in a foreign entity, and pays its U.S. subsidiary the arm's length price of $45 for the services performed in the United States.

Under both of these business models, the U.S. tax liability is limited to the 21 percent on the $5 of profits ($1.05), whereas the U.S. integrated service provider could face tax liability of $6 for the same transaction. Putting a U.S. integrated service provider at such an extreme competitive disadvantage is obviously contrary to the objectives of the TCJA, and could force the U.S. integrated service provider to outsource the foreign portion of services, potentially sacrificing service quality and growth opportunities. This result is further exacerbated by the other provisions that a U.S. multinational company is subject to, such as the new global intangible low-taxed income provisions of section 951A. Section 951A subjects earnings of a controlled foreign corporation to potential U.S. taxation, with no foreign tax credits allowed for section 59A. However, under the alternative business models described above, there is no incremental U.S. taxation above the $1.05 paid on the $5 of profit earned on the U.S. services provided to the customer.

This example demonstrates why clear and practical guidelines for application of the BEAT provision are needed. Without consideration of actual business operating models, section 59A could have significant unintended and harmful consequences for the U.S. economy and the intended stimulation of U.S. economic investment and growth. Indeed, the BEAT could have the effect of disadvantaging U.S.-based multinationals and reducing the relative attractiveness of investment in the United States. For example, to avoid the imposition of the BEAT, taxpayers could forego bonus depreciation to avoid reducing their regular tax liability below the BEAT, thus unintentionally undermining the TCJA's purpose of encouraging business investment in the U.S. and actually creating a disincentive for that investment.

The delivery of packages from a U.S. location to a foreign destination represents a U.S. export transaction. It would be counterproductive to the policy of encouraging exports⁷ if the BEAT provision were to impose a uniquely heavy tax burden on companies (such as FedEx) that are hired to facilitate such exports. Companies that deal in tangible goods may not face similarly severe consequences because the BEAT explicitly excludes payments that are accounted for in cost of goods sold. BEAT guidance for service businesses should be developed in a way that keeps the tax code neutral between businesses that sell services and those that sell physical products.

Accordingly, FedEx respectfully requests that the Treasury and IRS use the broad grant of authority provided in section 59A(i) to issue guidance that will allow U.S. headquartered globally integrated service providers to compete on equal footing with foreign headquartered competitors, in a manner consistent with legislative intent.

IV. Clarifying Language is Needed Regarding the Scope of the SCM Exception Under Section 59A(d)(5)

Section 59A(d)(5) provides that a base erosion payment does not include any amount paid or accrued for services that meet the requirements for eligibility for use of the SCM under section 482 (determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure), if the amount constitutes the service costs with no markup component (the SCM exception).

FedEx lauds Congress for enacting the SCM exception and encourages Treasury and the IRS to issue guidance that applies the SCM exception in an appropriate and practical manner. Specifically, we respectfully request that guidance address three aspects of the SCM exception.

A. The SCM Exception Should Expressly Apply to Qualifying Services Whether or Not the Services Constitute a Fundamental Element of a Taxpayer's Core Business

The SCM exception applies only if payments relate to “services which meet the requirements for eligibility for use of the [SCM] under section 482 (determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure).”⁸ The requirements for use of the SCM, as described in Treas. Reg. § 1.482-9(b), include the following:

Focusing on the third requirement of the SCM identified above, Treas. Reg. § 1.482-9(b)(5) precludes certain services from satisfying the SCM requirements if those services “contribute significantly to fundamental risks of business success or failure in one or more trades or businesses of the controlled group.”⁹ The regulations describe this condition as follows:

Section 59A(d)(5) expressly eliminates this requirement as a condition for qualifying for the SCM exception, providing that whether the services meet the requirements for use of the SCM under section 482 is “determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure.”¹⁰ The Conference Report explanation confirms the intention to eliminate this requirement, stating that “a base erosion payment does not apply to any amount paid or accrued by a taxpayer for services if such services meet the requirements for eligibility for use of the [SCM] described in Treas. Reg. § 1.482-9, as in effect as of the date of enactment of TCJA, without regard to the requirement that the services not contribute significantly to the fundamental risks of business success or failure . . .”¹¹

The statutory language and the legislative history thus make it clear that the SCM exception applies to otherwise qualifying services — i.e., services that meet the other requirements for use of the SCM under section 482 — even if the services contribute significantly to fundamental risks of a business' success or failure under the regulatory standards. Moreover, because these services would not qualify for the exception in Treas. Reg. 1.482-9(b) due to the business judgment rule, the amount paid or accrued for the services must consist of two components, a cost component and a markup component, to comply with section 482. Accordingly, the guidance on this provision should follow the statutory language and confirm that the SCM exception is available for the cost component of the amounts paid or accrued for services that contribute to key competitive advantages, core capabilities, or fundamental risks of success or failure of a trade or business of the taxpayer.¹²

B. The SCM Exception Should Expressly Apply to the Cost Component of Qualifying Services Regardless of Whether the Services Payment Contains a Markup Component

Section 59A(d)(5) excludes from base erosion payments “any amount paid or accrued by the taxpayer for services” provided that the services meet the SCM exception under Treas. Reg. § 1.482-9(b) (aside from the requirement that the services not contribute significantly to the fundamental risks of business success or failure) and the “amount constitutes the total services cost with no markup component.” It is unclear whether the SCM exception is available for the cost portion of an otherwise qualifying service payment that also includes a markup component. FedEx concludes that the statutory language, the structure and purpose of the provision, and the legislative history clearly mandate exclusion of the cost component of an otherwise qualifying service payment, whether or not a markup was paid as part of the total service charge. FedEx suggests that there is no policy reason for distinguishing between the cost components of marked up payments and non-marked up payments that otherwise qualify for the SCM exception. Therefore, we recommend that the guidance on this provision confirm that the cost component of a payment made for eligible services is excluded under the SCM exception even if the total service charge also includes a markup component.

Under the statutory language, an amount is excluded as a base erosion payment if three conditions are met: (1) there must be an amount (i.e., “any amount”); (2) that amount must be paid or accrued for eligible services; and (3) the amount must constitute the total services cost with no markup component. The cost component of a marked up service charge satisfies all three conditions. Therefore, the statutory language does not appear to provide any basis for excluding from the SCM exception the cost component of a service payment although the total payment includes a markup component.

To illustrate, assume that a U.S. corporation pays service charges to a foreign related party for various services. For the taxable year, the U.S. corporation accrues a total service charge for one particular qualifying service of $106, consisting of total services costs of $100 and a markup of $6. The amount of $100 in this example is an amount paid for eligible services that constitutes the total services costs with no markup component. The statutory language plainly does not treat this amount as a base erosion payment.

The structure and purpose of the BEAT provision also supports this plain-meaning application of the statutory language. One of the requirements for satisfying the SCM exception is that the services at issue must be covered services, as described in Treas. Reg. § 1.482-9(b)(3). These covered services may either be (1) specified covered services found in guidance issued by the Treasury Department and the IRS,¹³ or (2) low margin covered services. Low margin covered services are controlled services for which the median arm's-length charge includes a markup on total services cost at or below a particular threshold.¹⁴ Thus, the statute is directly tied to SCM regulations under section 482 that explicitly apply to service charges that, at arm's length, include a markup component. The SCM regulation permits these services to be charged at cost only as an elective safe-harbor, recognizing that a true arm's-length charge would include a markup.

Further, the internationally recognized arm's-length principle — as reflected in the OECD Guidelines, the associated-enterprises articles of income tax treaties, and the domestic transfer pricing rules of most countries (which are largely consistent with the Treasury regulations under section 482) — generally require foreign entities to recognize a profit element in their intercompany transactions, whether those transactions cover goods or services. As a result, it is generally expected that service charges paid to foreign entities, even for services that qualify for the SCM under section 482, would include a markup component.¹⁵ To eliminate the entire exception contemplated by section 59A(d)(5) because a payment includes a required markup component would essentially undo the exception in most instances. The recommended guidance is therefore necessary to give reasonable scope to the SCM exception, in recognition of the common, and often required, business practice of compensating the foreign service provider with a profit component.

The relevant legislative history confirms that Congress did not intend the payment of a markup to nullify application of the SCM exception to any and all components of an otherwise eligible service charge. During the consideration of the Senate bill, Senate Finance Committee Chairman Orrin Hatch (R-UT) explicitly announced that the “intent of the provision is to exclude all amounts paid or accrued for services costs” when a markup was also paid for the same service.¹⁶ The Conference Report adopted the Senate bill provision, with only one change to the statutory language: the word “component” was added to the language in section 59A(d)(5) requiring that the excluded amount constitute the total services cost “with no markup component.” The addition of the word “component” helpfully clarifies and conforms the statutory text to make it consistent with Chairman Hatch's floor statement, by acknowledging that service charges may consist of different components representing both cost components and markup components.

The Conference Report explanation also includes language describing the SCM exception. It states that “a base erosion payment does not include any amount paid or accrued by a taxpayer for services . . . if the payments are made for services that have no markup component.”¹⁷ This descriptive language is ambiguous in certain respects. However, it certainly does not provide any clear indication that Congress intended the SCM exception to be applied in a manner contrary to the provision's plain meaning and the prior legislative history discussed above. In particular, if the language is read to refer to “services” that have “no markup component,” one might conclude that any service compensated with a marked up service charge was not intended to qualify for the SCM exception. Such a reading would appear to be incorrect, however, for several reasons.

First, by “turning off” the business judgment rule, section 59A(d)(5)(A) explicitly recognizes that certain services for which a markup must be charged under section 482 could satisfy the exclusion under section 59A(d)(5). Second, while the legislative history refers to “payments” that have no markup component, the statute excludes from base erosion treatment “amounts” paid or accrued for certain services as long as the “amount” to be excluded does not have a markup component. In normal parlance, a “payment” can and frequently does consist of several “amounts.” For example, a mortgage payment typically consists of an interest amount, a principal amount, and an escrow amount. Similarly, a deductible payment to an affiliate may consist of a “cost” amount and a “markup” amount. Finally, it makes no sense to refer to a “service” that does or does not include a markup component. A service, itself, does not have the quality of including or excluding a markup; rather, it is a service charge or an amount paid that may or may not include a markup.

For all these reasons, a more logical reading of the legislative history would consider the language to refer to “[amounts] . . . that have no markup component.” This more natural reading, referring to application of the provision to amounts having no markup component, would be consistent with the clear intention that the SCM exception apply only to the cost component of service charges. Thus, the Conference Report language should not be artificially read in a manner that contradicts the statutory language, the structure of the provision, and the earlier legislative history discussed above.

Moreover, no policy goal is served by excluding a service payment that includes no markup for one taxpayer, but then including as a base erosion payment the entire amount paid by another taxpayer for an identical service in identical circumstances solely because the other taxpayer's total service charge includes a modest (and perhaps required) markup. In both cases, the cost component of the service charge has an identical impact on the U.S. tax base and an identical effect on the taxpayer's taxable income. The underlying policy goals would be best served by excluding the identical amount, representing the cost of the services, in both situations. Otherwise, the provision would mandate an unusual “cliff effect” that would be triggered if even one cent of markup is paid for a service, an effect that would not appear to serve any rational purpose.

Without the requested guidance, it is easy to contemplate instances of dissimilar treatment for economically identical transactions. If a customer pays a U.S. corporation for services provided by both the U.S. corporation and its related foreign entity, the related foreign entity will necessarily incur costs to perform its services. Assume for this example that the customer pays the U.S. corporation $500 and the related foreign entity incurs $200 in costs in fulfilling the services for the customer. If the U.S. corporation pays $200 to its foreign affiliate for its services, constituting the total services cost with no markup component, the entire $200 is clearly excluded as a base erosion payment under section 59A(d)(5). However, this would mean that the foreign affiliate receives no profit from its services, contrary to the arm's-length standard, foreign transfer pricing laws, and general business practices. If, in an effort to satisfy these standards, laws, and practices, the U.S. corporation pays $210 to its foreign affiliate for its services, constituting the total services cost with a $10 markup, there is no policy reason for including the entire $210 amount as a base eroding payment. Rather, the same $200 that would have been excluded had there been no markup component should remain excluded. It seems nonsensical to provide for wholly different BEAT consequences for outbound service charges solely because the charge paid includes a small markup, calculated at arm's-length.

In the absence of the requested guidance, taxpayers may have greater incentives to revise their contractual arrangements and revenue recognition policies in order to reduce the onerous consequences resulting from this different treatment of economically identical transactions. For instance using the example above, if the foreign related entity contracts with the customer in addition to the U.S. corporation and books $210 of revenue, then there would be no payment subject to the BEAT. This is the case despite the fact that the economic situation of the related parties is the same as the U.S. corporation paying $210 to the foreign affiliate for its services, the entirety of which payment could be subject to the BEAT in the absence of the requested guidance. There is no reason for the adoption of guidance that results in different BEAT consequences in identical economic situations and would not only encourage, but perhaps necessitate, taxpayers to adopt different contractual structures and revenue recognition policies in order to remain competitive. A U.S. taxpayer also may adopt the possible solution of outsourcing these offshore services to a foreign third party rather than using a related party, with the unintended consequence of shrinking the taxpayer's international footprint and indirectly affecting the company's growth and economic contribution in the U.S.

Guidance that does not unduly restrict the availability of the SCM exception, but gives the exception reasonable scope in line with FedEx's recommendation, would also help to mitigate the imbalanced treatment of service businesses as compared to manufacturing businesses under the BEAT. Base erosion payments do not include amounts paid by U.S. corporations to acquire goods that affect only the U.S. payor's cost of goods sold, rather than giving rise to a deduction.¹⁸ Because payments reflected in cost of goods sold are not base erosion payments, manufacturing companies may exclude significant payments made to foreign related parties from the BEAT, regardless of whether those payments include a markup component. In fact, the entire amount paid by these companies to acquire goods, both the cost component and any markup component, is excluded.

The only corresponding relief provided to companies operating in the services sector is the SCM exception. Thus, to ensure equitable treatment of the many U.S. companies that deal in services rather than goods, the SCM exception should not be construed in a restrictive manner that makes it useless to most U.S. headquartered globally integrated service providers. Moreover, the SCM inherently limits the type of transactions that would qualify for a BEAT exception and therefore excludes the type of intercompany transactions targeted by section 59A that may have as a primary objective to erode the U.S. tax base (e.g., royalties, interest, etc.).

C. Taxpayers Should Not Be Required to Keep Separate Accounts to Qualify for the SCM Exception

One of the requirements for excluding an amount paid or accrued to a foreign related party for services is that the amount constitutes the “total services cost with no markup component.”¹⁹ On December 1, 2017 (before the TCJA was enacted but after the Senate amendment was introduced), Senator Portman and Chairman Hatch conducted a colloquy on the Senate floor regarding this portion of the SCM exception.²⁰ Their colloquy considered a payment to a foreign related party that included a markup. The discussion considered a fact pattern in which the total service charge was bifurcated into two separate accounts: one consisting of the total services cost with no markup and the other consisting of the markup amount.

Senator Portman stated:

I would like to clarify a point in connection with the application of the base erosion anti-abuse tax in the Tax Cuts and Jobs Act to services companies. The act provides an exception from the base erosion anti-abuse tax for services. The act limits the exception to the “total services cost with no markup." As a practical matter, companies account for amounts paid or accrued for services in a variety of ways. I would like to clarify that, if in a transaction a company used one account for services cost with no markup and another accounted for any additional amounts paid or accrued, that the first account would be subject to the exception under the bill.

To which Chairman Hatch responded:

The Senator is correct. The intent of the provision is to exclude all amounts paid or accrued for services costs with no markup. Thus amounts paid or accrued in that account would be excluded from the base erosion anti-abuse tax. Other accounts related to the same transaction may or may not be excepted from this tax. [emphasis added]

Treasury and the IRS should issue guidance that confirms the intent to exclude the cost component of service charges when recorded in a separate account from additional amounts, as contemplated by the colloquy. The guidance should further provide, however, that recording amounts in separate accounts is not a requirement. This method of internal accounting, if required, may be onerous and should be considered entirely unnecessary. Requiring taxpayers to undertake expensive modifications to internal accounting systems (e.g., reconfiguring enterprise resource planning system modules) to satisfy such a purely formalistic requirement would be unduly burdensome. Further, section 59A(d)(5) does not directly require the use of two separate accounting systems. Rather, the section 482 regulations already require, as one of the conditions for qualifying for the SCM (and thus for qualifying for the SCM exception) that taxpayers maintain books and records that clearly identify the “total services costs” associated with the services.²¹ Specifically, the section 482 regulations provide:

This existing regulatory requirement should be sufficient to protect the interests of the government in ensuring that the costs associated with qualifying services are properly identified and verifiable, and that the IRS has the information necessary to audit the application of the SCM exception. This regulation thus satisfies the same goal as the separate accounts considered in the Senate floor colloquy. Moreover, while the colloquy discussed a fact pattern in which separate accounts were kept, the colloquy does not affirmatively state that separate accounts were required, nor did it state that the SCM exception would be unavailable when separate accounts are not maintained.

For these reasons, FedEx requests that Treasury and the IRS issue guidance that expressly provides that taxpayers need not keep separate accounts for the total services cost and any markup to qualify for the SCM exception.

V. The Characterization of Payments Made to a Foreign Partnership with a U.S. Partner Should Expressly Be Made at the Partner Level Rather than at the Partnership Level

Section 59A does not provide any guidance on deductible payments made to a foreign partnership with a U.S. partner.

The treatment of partnerships across the Code is not uniform. Tax rules addressing the relationship between a partner and a partnership are, as a general matter, a mix of (1) entity principles under which a partnership is treated as a separate entity, and (2) aggregate principles under which a partnership is treated as a conduit of its partner.

Congress addressed this issue in the legislative history of subchapter K, which states that for purposes of interpreting Code provisions outside of subchapter K, a partnership may be treated as either an entity separate from its partners or an aggregate of its partners, depending on which characterization is more appropriate to carry out the purpose of the particular Code or Treasury regulation section under consideration.²³

The IRS and Treasury have previously acknowledged the potentially broad application of aggregate principles to a partnership. Echoing the intent in the legislative history, that aggregate or entity principles be applied based on the most “appropriate”²⁴ treatment, Treas. Reg. § 1.701-2(e)(1) provides that 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.”²⁵ This rule is an acknowledgement by the IRS and Treasury that the hybrid nature of a partnership may potentially cause a partnership to be treated as an aggregate under any provision of the Code.

Treasury and the IRS should issue guidance clarifying that the characterization of potential base erosion payments made to a partnership is determined by treating the partnership under the aggregate approach rather than under the entity approach.

An aggregate approach would both be more consistent with the purpose of section 59A and more effective in protecting the U.S. tax base from taxpayers making extensive base erosion payments to foreign related parties.²⁶ For example, consider a foreign partnership with a 75 percent U.S. partner and a 25 percent foreign partner that is related to an applicable taxpayer. If the applicable taxpayer makes a potentially base eroding payment to this partnership of $500, treatment under the aggregate view would include only the portion of the payment that is allocable to the foreign related partner as base eroding ($125), whereas under the entity view, the entire $500 payment may be considered base eroding. Because the U.S. partner in the partnership would be required to include $375 (75 percent share of the $500 payment) in its income, treatment under the entity view would often result in taxation of a portion of the payment made to the partnership without allowing a corresponding deduction (i.e., the $375 would be subject to U.S. taxation by the U.S. partner, and the $375 would be brought back into the taxpayer's MTI calculation for the applicable taxpayer making the payment).

Thus, the deductible payment should not be viewed as a base erosion payment to the extent the payment is ultimately subject to tax in the United States. A contrary approach may create instances of inappropriate double taxation and would be inconsistent with the TCJA's goal to make U.S. companies more globally competitive. As a result, we recommend applying the aggregate approach to determine the appropriate treatment under section 59A of payments made to a partnership. This approach would also protect the U.S. fisc from the use of partnerships to circumvent the application of section 59A.

VI. Payments Otherwise Subject to U.S. Federal Income Tax Should Be Expressly Exempted from BEAT

Similar to the principles governing the treatment of partnerships, base erosion payments to foreign related parties that are otherwise subject to U.S. federal income tax under other Code sections, such as the new global intangible low-taxed income provisions of section 951A, should be excluded from the application of section 59A. If these payments are included when calculating MTI, significant amounts paid by applicable taxpayers to foreign related parties may be subject to double U.S. taxation. Congress clearly wanted to avoid this outcome when it excluded from the scope of section 59A deductible payments that are subject to U.S. federal income tax by reason of section 881 for which withholding tax under section 1442 is imposed.²⁷ Thus, it appears that Congress realized the potential for double taxation of payments by a U.S. taxpayer to a foreign related party and provided a specific exception for these payments.

The BEAT provision aims to tax certain payments made by applicable taxpayers to their foreign related parties in an effort to prevent those payments from eroding the U.S. tax base. When these payments are taxable by the United States under other provisions of the Code, the BEAT provision should not be necessary as there is no underlying base erosion concern to address. In fact, to subject these payments to the BEAT would result in economic double U.S. taxation on these payments, which would undermine a primary goal of the TCJA to make U.S. companies more competitive.²⁸

Accordingly, Treasury and the IRS should issue guidance expressly stating that payments otherwise subject to U.S. tax are exempted from the BEAT.

VII. Late Payments and Underpayments of Tax as a Result of the New BEAT Provision Should Be Exempt from Penalties for Taxable Years Beginning Prior to December 31, 2018

Given the novelty of section 59A and the lack of existing guidance from Treasury and the IRS on the application of these provisions, FedEx asserts strongly that guidance should provide relief to taxpayers for taxable years beginning on or before December 31, 2018, from penalties associated with late payments or underpayments of tax resulting from the BEAT statute. Taxpayers have not been afforded enough time or guidance to understand how these complex new provisions will impact their businesses. As such, they should not be subject to penalties if the IRS interprets the BEAT provision differently than a taxpayer operating without sufficient guidance.

The IRS has already recognized that it is unfair to subject taxpayers to penalties for payment deficiencies related to new section 965, which imposes a transition tax on U.S. shareholders of foreign corporations with untaxed foreign earnings. To address this potential unfairness, the IRS has issued guidance offering relief from penalties for both underpayments and late payments, depending on the circumstances, to certain taxpayers subject to the 965 transition tax.²⁹ Considering that there is even less guidance regarding application of the BEAT provision than there is guidance regarding section 965, taxpayers should be afforded at least the same relief for late payments or underpayments related to calculations under section 59A.

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We appreciate your consideration of our requests detailed above. Unless it is made more manageable, the BEAT has the potential to impose significant additional tax on a service company's normal business transactions. These costs will put these companies at a competitive disadvantage versus their foreign competitors, which will result in less U.S. investment, moving critical business operations offshore to minimize outbound payments, and downsizing international operations by outsourcing functions to third parties.

The guidance requested will provide much needed clarity and will provide for appropriate, manageable, and practical application of the BEAT rules that is consistent with the goals of section 59A and the TCJA.

Respectfully submitted,

Alan B. Graf Jr.
Executive Vice President & Chief Financial Officer

Mark R. Allen
Executive Vice President, General Counsel & Secretary

FedEx Corporation

If you have any questions please contact:

Robert L. Brown (Bobby)
Corporate Vice President Tax
Direct: 901-818-7131

Joseph L. Schiffhouer (Joe)
Corporate Vice President Tax/Employee Benefits Law
Direct: 901-818-7116

Cc:
Kevin C. Nichols
Senior Counsel (Office of Tax Policy)
Department of the Treasury

Mr. Douglas L. Poms
International Tax Counsel
U.S. Department of the Treasury

Daniel Winnick
Attorney-Advisor (Office of Tax Policy)
Department of the Treasury

Marjorie A. Rollinson
Associate Chief Counsel (International)
Internal Revenue Service

Daniel M. McCall
Deputy Associate Chief Counsel (International)
Internal Revenue Service

Peter D. Merkel
Senior Technical Reviewer, Office of Associate Chief Counsel (International)
Internal Revenue Service

Anthony J. Marra
Attorney, Office of Associate Chief Counsel (International)
Internal Revenue Service

Jennifer S. Acuna
Chief Tax Counsel
Senate Committee on Finance

Barbara M. Angus
Chief Tax Counsel
House Committee on Ways and Means

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Appendix A

Text for Late Payments and Underpayments of Tax as a Result of section 59A for Taxable Years Beginning prior to December 31, 2018

Taxable years beginning before December 31, 2018 will be regarded as a transition period for purposes of IRS enforcement and administration of penalties associated with any underpayment of the base erosion anti-abuse tax imposed under new section 59A of the Code. With respect to this transition period, the IRS will take into account the extent to which a taxpayer has made good faith reasonable efforts during the transition period to comply with the requirements under section 59A in computing the tax. This relief is provided, in part, as a response to taxpayer requests for relief in light of the complexity of this new provision and the ambiguity in how to apply the statutory provision. This relief is also provided in order to ensure that the implementation and administration of the new tax is orderly, efficient, and effective for both taxpayer and the IRS.

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1.59A-1 Base erosion anti-abuse provision.

([ ]) Definitions. The following definitions apply for purposes of section 59A and the regulations under this section, unless otherwise specified in [ ].

([ ]) Base erosion payment. — (1) In general. Except as otherwise provided in subparagraph (ii) of this paragraph [ ] the term base erosion payment means any of the following —

(i) 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 chapter 1 of the Code;

(ii) 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 for depreciation (or amortization in lieu of depreciation);

(iii) Any premium or other consideration paid or accrued by the taxpayer to a foreign person which is a related party of the taxpayer for any reinsurance payments which are taken into account under sections 803(a)(1)(B) or 832(b)(4)(A); and

(iv) Any amount paid or accrued by the taxpayer with respect to a surrogate foreign corporate group (as defined in paragraph [ ] of this section) which results in a reduction of the gross receipts of the taxpayer.

(2) List of excluded payments. Notwithstanding paragraph (1) of this section [ ] the term base erosion payment shall not include any amount (or portion thereof) paid or accrued by the taxpayer —

(A) That constitutes an eligible SCM service charge (as defined in paragraph [ ] of this section);

(B) To the extent a U.S. shareholder includes such amount in its pro rata share of (i) tested income as defined in section 951A(c)(2)(A) or (ii) subpart F income as defined in section 952(a);

(C) That meets the qualified derivative exception (as defined in paragraph [ ] of this section);

(3) Eligible SCM service charge.

(a) In general. The term eligible SCM service charge means the amount of a service charge paid or accrued by the taxpayer that meets the following two requirements—

(i) the amount is paid or accrued for an eligible service (as defined in paragraph (b) of this section);

(ii) the amount is equal to the service provider's total services costs of rendering the eligible service as defined in § 1.482-9(j) as in effect on December 22, 2017.

(b) Eligible service. The term eligible service means a service that meets all of the following requirements —

(i) the service is either

(A) a specified covered service described in Revenue Procedure 2007-13, without regard to any subsequent revocation, supersession, modification or amendment of such revenue procedure, or

(B) a low-margin covered service as defined in § 1.482-9(b)(3)(ii) as in effect on December 22, 2017;

(ii) the service is not an excluded activity as defined in § 1.482-9(b)(4) as in effect on December 22, 2017; and

(iii) the taxpayer maintains permanent books and records that are adequate to permit verification by the Commissioner of the total services costs incurred by the renderer of the service with respect to the service, including a description of the service in question, identification of the renderer and the recipient of such service, and sufficient documentation to allow verification of the methods used to allocate and apportion such costs to the service in question in accordance with § 1.482-9(k).

A service meeting these requirements constitutes an eligible service without regard to whether the service contributes significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure in one or more trades or businesses of the controlled group, as described in § 1.482-9(b)(5).

(c) Amount excluded. If the total amount paid or accrued by the taxpayer for a taxable year for an eligible service exceeds the total services costs of the service, then the amount excluded as an eligible SCM service charge is limited to the total services costs, and the amount paid or accrued by the taxpayer for the eligible service for the taxable year that exceeds the total services costs shall not be treated as an eligible SCM service charge. For this purpose, the amount paid or accrued by the taxpayer that equals the total services costs shall be treated as an eligible SCM service charge even if such amount is recorded by the taxpayer in the same account as the amount paid or accrued for the service that exceeds the total services costs.

(d) Example. The following example illustrates this subsection XX. USCo is a U.S. corporation that is an applicable taxpayer, and ForSub is a foreign related person. For 2019, USCo pays ForSub a total of $106 for an eligible service. The total services costs of ForSub with respect to this service for 2019 is $100. The amount USCo excludes as an eligible SCM service charge for 2019 is $100. USCo cannot treat the $6 amount it paid to ForSub for the eligible service as an eligible SCM service charge.

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([ ]) Special rules for determining base erosion payment.

(1) Application to partnerships. (i) Deductible payments made to a partnership. For purposes of determining whether a deductible payment to a partnership is treated as a base erosion payment (as defined in paragraph [ ] of this section) each partner will be treated as receiving directly a proportionate share of the payment. However, to the extent any portion of the payment is subject to withholding under section 1446 by a partnership to a foreign partner then such amount shall not be treated as a base erosion payment.

(ii) Deductible payments paid or accrued by a partnership. For purposes of determining whether a deductible payment paid or accrued by a partnership is treated as a base erosion payment (as defined in paragraph [ ] of this section) each partner will be treated as making directly a proportionate share of the payment.

(iii) Examples. The following examples illustrate the principles of this paragraph ([ ]).

Example 1. FPRS, a foreign partnership, has two partners, USP and FP. USP and FP are not related. USP, a U.S. corporate partner, has a 75% interest in FPRS and FP, a foreign partner, has the remaining 25% interest in FRPS. XCo, a U.S. corporation that is an applicable taxpayer within the meaning of section 59A(e), is wholly-owned by USP. XCo makes a $500 deductible payment for services to FRPS. The payment by XCo to FRPS is not treated as a base erosion payment since each partner, USP and FP, is treated as receiving directly their proportionate share of the deductible payment, and neither the payment to USP nor FP would be a base erosion payment made to a foreign related party.

Example 2. Same facts as in Example 1, except that USP and FP are related. In this case, $125 of the payment by XCo to FRPS is treated as a base erosion payment since that amount reflects FP's proportionate share (25%) of the deductible payment and FP is a foreign related person to XCo.

Example 3. USPRS, a US partnership, has two partners, USP and FP. USP, a U.S. corporate partner, has a 75% interest in USPRS and FP, a foreign partner, has the remaining 25% interest in USPRS. YCo, a foreign corporation, is wholly-owned by USP. USP, YCo, and FP are related. USPRS makes a $500 deductible payment for services to YCo. In this case, $375 of the deductible payment by USPRS is treated as paid directly by USP to YCo, and is treated as a base erosion payment because YCo is a foreign related person with respect to USP.