Attorneys Seek Expanded De Minimis Rules Under BEAT Provisions

January 13, 2019

Mr. David J. Kautter
Assistant Secretary for Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220

Mr. Charles P. Rettig
Commissioner of Internal Revenue
1111 Constitution Avenue, N.W.
Washington, DC 20224

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

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

Mr. Douglas Poms
International Tax Counsel
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220

Re: Comments on Proposed BEAT Regulations (REG-104259-18):
Need for De Minimis and Transitory Ownership Exceptions to Special BEAT Tax Rates for Banks and Registered Securities Dealers

Dear Sirs:

These comments are submitted with respect to certain regulations issued in proposed form regarding section 59A.¹ We respectfully request that the Internal Revenue Service (the “Service”) and Treasury Department (“Treasury”) issue guidance expanding the limited de minimis rules previously proposed in connection with the special BEAT rules for groups that include banks or registered securities dealers. In particular, we recommend that a modified de minimis exception, as described below, apply not only for purposes of the special base erosion percentage threshold for such groups but also for purposes of the special tax rate for such groups set forth in section 59A(b)(3)(A).

We each submit this letter on our own behalf, but we note that we may have clients that could be affected by action or inaction in response to this request for guidance and clarification.

I. Background

We filed a comment requesting certain guidance under section 59A prior to the issuance of the proposed regulations.² In that letter we requested that the Service and Treasury include, in any implementing or interpretive regulations with respect to section 59A, a de minimis exception for certain taxpayers that are members of an affiliated group that includes either or both a bank³ or registered securities dealer (hereinafter “financial members”).⁴ The request addressed two aspects of “de minimis,” one quantitative and a second temporal with respect to what might only be brief membership of a financial member in a nonfinancial group.

As relevant here, section 59A(b)(3)(A) provides that, in the case of a taxpayer described in section 59A(b)(3)(B) that is an applicable taxpayer for any taxable year, each tax rate percentage otherwise in effect under paragraphs (1)(A) and (2)(A) is increased by one percentage point. A taxpayer is described in section 59A(b)(3)(B) if the taxpayer is a member of an affiliated group (as defined in section 1504(a)(1)) which includes (i) a bank (as defined in section 581) or (ii) a registered securities dealer under section 15(a) of the Securities Exchange Act of 1934.

The legislative history does not explain the reason for the special rates in section 59A(b)(3). Presumably, the provision is intended to reach affiliated groups in which significant opportunities for, or peculiar harms from, base erosion payments exist because of the presence of a financial member in the group. Observing the history of the development of section 59A, it would appear that the provision was not aimed at activities that earn conventional non-financial revenues within the domestic market, but rather at trading activities (whether through derivatives or otherwise) for the account of the financial institution that provide significant opportunities for shifting income abroad.

II. De Minimis Provision Affecting section 59A(e)(1)(C) Set Forth in Prop. Treas. Reg. §1.59A-2(e)

Although Prop. Treas. Reg. §1.59A-2(e)(iii) provides a limited de minimis exception for banks and registered securities dealers for purposes of determining the base erosion percentage threshold for an applicable taxpayer under section 59A(e)(1)(C), this exception is not sufficient to provide relief for the concerns raised in our prior comments.⁵ Specifically, the proposed de minimis exception provides that the special base erosion threshold of 2 percent (rather than the general base erosion threshold of 3 percent) does not apply to an affiliated group if the total gross receipts attributable to the bank and registered securities dealer members of that group are less than two percent of the aggregate gross receipts of the group.⁶ However, as further discussed below, if the base erosion percentage of the non-financial members of the affiliated group otherwise exceeds the general base erosion threshold of 3 percent, the special additional BEAT rate of one percentage point of section 59A(b)(3) would apply no matter how insignificant the financial members of the group are relative to the non-financial members. For the reasons set forth in our prior comments, we see no policy basis for such a result.

III. Request for De Minimis and Transitory Ownership Exceptions

The proposed regulation addresses one rather limited aspect of the unintended application of section 59A(b)(3): the situation in which an affiliated group base erosion percentage would be at or below 3 percent, but the presence of a financial member would, pursuant to section 59A(e)(1)(C), reduce the testing percentage to 2 percent in order to determine if a taxpayer included in such a group is an “applicable taxpayer.”

Although that is a sensible application of a de minimis rule, it does not address a more likely unintended application of section 59A: the increase in the base erosion tax by one percentage point,⁷ for an affiliated group that has a base erosion percentage at or above 3 percent and also includes one or more financial members that together account for de minimis components of gross receipts, gross income or de minimis components of any base erosion payments by the affiliated group.

For example, under the proposed regulations, an affiliated group with a registered securities dealer that accounts for less than 2 percent of gross receipts of the affiliated group, or less than 1 percent of base erosion payments by the affiliated group, would be subject to the higher BEAT tax rate (i.e., increased by one percentage point) on all base erosion payments by the other (non-financial) members of the group.

Examining the history of the increased rate BEAT rate for certain taxpayers, it appears that affiliated groups that have only de minimis financial members were not the intended targets for the increased BEAT tax rate. Treasury and the Service seem to recognize that a de minimis exception is appropriate for affiliated groups that are not principally engaged in banking or securities dealing, stating on page 91 of the Notice of Proposed Rulemaking the following:

Although this stated rationale explains the basis for the limited de minimis exception proposed for purposes of the base erosion percentage test, this rationale should apply with equal force for purposes of the increased BEAT rate.

Accordingly, we respectfully request that the proposed regulations be modified to apply a de minimis exception as well as a transitory ownership exception in Prop. Treas. Reg. §§ 1.59A-1(b) and 1.59A-5 for purposes of the special tax rate set forth in section 59A(b)(3)(A).

Specifically, we request that Treasury and the Service issue guidance providing for three exceptions⁸ to the special taxpayer status described in section 59A(b)(3)(B). The first exception could be a size-based de minimis exception and provide that a taxpayer is not described in section 59A(b)(3)(B) if the aggregate gross income of all financial members described in section 59A(b)(3)(B) is less than two percent of the aggregate gross income of the affiliated group.

The second exception could apply where the financial members of the affiliated group make no more than a de minimis amount of base erosion payments, measured by reference to aggregate affiliated group base erosion payments. In light of the history of the provision, base erosion payments for this purpose would be specially defined to disregard the exclusion under section 59A(h) for qualified derivative payments. It seems unlikely that taxpayers would need to expend substantial time analyzing derivative transactions for purposes of applying this de minimis rule; real financial institution groups would know that they exceed the threshold, while non-target incidental groups would have little or no derivative activity.

The third exception would be for transitory ownership if a financial member is in the affiliated group for only a small proportion of a taxable year. Such an exception would allow timely and orderly disposition of financial members that might have been included in a group of companies acquired by an affiliated group. Such an exception would provide that a taxpayer is not described in section 59A(b)(3)(B) if a bank or registered securities dealer was disposed of by an affiliated group within a specified period of time (e.g., within 90 days⁹ in a taxable year). This would provide time for an acquiring affiliated group to dispose of the financial member of a target affiliated group without the acquiring affiliated group itself becoming subject to the increased rate of BEAT tax under section 59A(b)(3)(A).

In order to protect the policy of the special rule for banks and registered securities dealers, Treasury and the Service could provide that the increased rate set forth in section 59A(b)(3)(A) would continue to apply with respect to the financial members themselves (but not to the non-financial members of the affiliated group).

The proposed exceptions should have the same effective date as that of section 59A itself (i.e., effective for base erosion payments paid or accrued in tax years beginning after December 31, 2017).¹⁰

One approach to including the requested changes in the proposed regulations would be to amend Prop. Treas. Reg. §1.59A-5(c)(2) to provide as follows:

Prop. Treas. Reg. §1.59A-1(b) would then be amended to define a “de minimis financial group” and a “financial member” by inserting after Prop. Treas. Reg. §1.59A-1(b)(9) the following:

The suggested de minimis test under new Prop. Treas. Reg. §1.59A-1(b)(10)(i)(A) set out above would apply a two percent of gross income threshold instead of the five percent of gross receipts threshold we originally requested.¹¹ Specifically, the suggested threshold establishes a test based on the aggregate section 61 gross income of the affiliated group,¹² which seems to better equate the relative value of the income of the financial and non-financial members of the affiliated group than a test based on gross receipts, while reducing the trigger point to two percent limits the exception to affiliated groups with only truly insignificant financial members.¹³

Again, please note, we suggest the inclusion of qualified derivative payments for the de minimis test under new Prop. Treas. Reg. §1.59A-1(b)(10)(i)(B). This would treat such payments as base erosion payments for purposes of determining whether an affiliated group is a de minimis financial group. This would further differentiate affiliated groups composed of banks and registered securities dealers from non-financial affiliated groups for which the increased rate of BEAT tax under section 59A(b)(3)(A) would be unwarranted.

We appreciate your consideration of our comments. We would be happy to discuss any questions you may have.

Sincerely,

Robert H. Dilworth
P.O. Box 40813
Washington, DC 20016
rhdilworth@rdilworth.com

Matthew A. Lykken
P.O. Box 40813
Washington, DC 20016
mlykken@potomaclaw.com

Caroline H. Ngo
McDermott Will & Emery LLP
cngo@mwe.com

Jeffrey M. O'Donnell
P.O. Box 40813
Washington, DC 20016
jmodon888@gmail.com