So Much Change Under BEAT Regs Requires Transition Rule, Firm Says

February 19, 2019

Secretary of the Treasury
c/o Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re:CC:PA:LPD:PR (REG-104259-18)
Proposed Regulations on Base Erosion and Anti-Abuse Tax

Dear Mr. Secretary:

These comments are filed on the Notice of Proposed Rulemaking (REG-104259-18) ("proposed regulations") published in the Federal Register on December 21, 2018, which provides guidance on the new base erosion and anti-abuse tax ("BEAT") (section 59A¹), at the request, and on behalf, of an affiliated group of companies that file a life/nonlife consolidated Federal income tax return subject to Treas. Reg. § 1.1502-47. 83 Fed. Reg. 65,956 (Dec. 21, 2018). These comments address an area on which the background to the proposed regulations (the "Preamble") requests comments — the add-back approach for computing modified taxable income ("MTI") and the practical effects of the alternative recomputation-based approach specified in section 59A(c). Preamble, at 83 Fed. Reg. 65,965. These comments also address the broader issue of the calculation under the proposed regulations of MTI in the context of a life/nonlife consolidated return.

In essence, these comments request that the final regulations provide an appropriate elective transition rule for taxpayers that file life/nonlife consolidated returns. This relief is necessary because these taxpayers have relied in good faith upon the statutory definition of MTI and current Treas. Reg. § 1.1502-47 in conducting their international insurance activities and did not, and could not, anticipate the major departures from the statute reflected in the proposed regulation's definition of MTI where there has been no tax avoidance of the type contemplated by section 59A(i). This limited transition relief is particularly appropriate for taxpayers filing life/nonlife consolidated returns because it is reasonable to expect that additional changes to the proposed regulations will be adopted to coordinate the amendments made to section 172 with Treas. Reg. § 1.1502-47. In other words, this unique class of taxpayers still does not know how the final regulations will depart from the statutory definition of MTI and the current life/nonlife consolidated return regulations in implementing BEAT.

Under section 59A(c), MTI is computed in the same manner as regular taxable income without regard to any base erosion tax benefit with respect to any base erosion payment or the base erosion percentage of any net operating loss ("NOL") deduction allowed under section 172 for the taxable year. Prop. Reg. § 1.59A-4 departs from the statutory definition of MTI, however, in two significant ways that impact life/nonlife consolidated returns. First, instead of using the taxable income recomputation approach specified by the statute, Prop. Reg. § 1.59A-4(b)(2) adopts an add-back approach whereby MTI is computed by adding to regular taxable income base erosion tax benefits and other specified items. Second, with respect to NOLs, Prop. Reg. § 1.59A-4(b) departs from the statute by requiring regular taxable income to be adjusted before the add-backs to exclude any NOL deduction that would cause or increase negative taxable income, and then the base erosion percentage of the reduced NOL is added back to the adjusted regular taxable income to arrive at MTI.

These departures from the statute may have significant, and apparently unintended, consequences for a taxpayer filing a life/nonlife consolidated return under section 1504(c)(2). Because of the interaction of the life/nonlife consolidated return rules and the proposed section 59A regulations, a taxpayer filing a life/nonlife consolidated return could, in many cases, be treated differently than other consolidated return taxpayers. These rules could result in an unreasonable calculation of MTI for a taxpayer filing a life/nonlife consolidated return if they are not applied to take into account the unique subgroup rules applicable to such taxpayers under Treas. Reg. § 1.1502-47.

We understand that the IRS is in the process of developing guidance on how the special rules in section 172 with respect to NOL carryforwards and carrybacks as a result of Pub. L. No. 115-97 (2017) (commonly referred to as the "Tax Cuts and Jobs Act of 2017" or "TCJA") for property-casualty insurance ("P&C") companies will apply in the context of consolidated returns, including life/nonlife consolidated returns. As part of that process, the IRS also is reviewing the numerous and complex rules for life/nonlife consolidated groups contained in Treas. Reg. § 1.1502-47. See Emily L. Foster, "ABA Section of Taxation Meeting: Rules Underway for Groups With Insurance Companies," Tax Notes, at 389 (Oct. 15, 2018). We anticipate that, if amendments to Treas. Reg. § 1.1502-47 are proposed, they will include clarifications that materially impact the computation of regular life/nonlife consolidated taxable income and MTI.

Therefore, because (a) the proposed regulations under section 59A do not consider the unique life/nonlife subgroup rules, (b) a mechanical application of the proposed rules could result in a computation of an inappropriate MTI that is different from other consolidated groups, and (c) there are likely to be additional changes to the life/nonlife rules, we respectfully request that the final regulations provide an election to taxpayers that file life/nonlife consolidated returns for the taxable year ending December 31, 2017,² to follow the statute in calculating MT1 (i.e., use a recomputation approach and allow NOLs to cause or increase negative taxable income) rather than the alternate rules in the proposed (or final) regulations, as long as the taxpayer adopts a reasonable and consistent method to track the use of NOL carryforwards and carrybacks taken into account in determining MTI to avoid any NOL double counting in MTI in multiple years. The election could be limited so that it is only applicable for taxable periods beginning before (i) new rules promulgated under section 59A that specifically take into account the unique subgroup approach to life/nonlife consolidation are generally applicable, or (ii) taxable years ending after December 31, 2019, whichever is later.³

I. BACKGROUND

Section 59A requires an applicable taxpayer to pay a tax equal to the base erosion minimum tax amount for the taxable year, which is based on MTI. Section 59A(a), (b)(1). MTI is computed under section 59A(c)(1) using a regular tax recomputation approach similar to the repealed alternative minimum taxable income computation. MTI is defined as "the [regular] taxable income of the taxpayer computed under this chapter [1] for the taxable year, determined without regard to (A) any base erosion tax benefit with respect to any base erosion payment, or (B) the base erosion percentage of any net operating loss deduction allowed under section 172 for the taxable year." Section 59A(c)(1).

The deduction allowed under section 172 for NOLs differs depending on the taxable year in which the NOL arose. The general rule is that an NOL deduction is limited to 80 percent of taxable income determined without regard to the NOL deduction. However, there are two exceptions to this general rule that permit unlimited NOL deductions: (1) pre-2018 NOL carryforwards, and (2) NOLs used against P&C company taxable income. Pub. L. No. 115-97, § 13302(e); section 172(f). With respect to these items, section 172 provides that the full amount of unused NOL carryforwards is available as a deduction in each carryover year so NOLs can cause or increase negative taxable income.

The regular tax recomputation approach to MTI and NOL rules are what section 59A(c) prescribes as the method by which MTI is computed. However, section 59A(i) grants Treasury the authority to prescribe regulations "as may be necessary or appropriate to carry out the provisions of this section."

BEAT Proposed Regulations

For consolidated groups, the proposed regulations adopt a single taxpayer approach in determining the applicable taxpayer and in determining MTI. "For purposes of determining whether the consolidated group is an applicable taxpayer (within the meaning of § 1.59A-2(b)) and the amount of tax due pursuant to section 59A(a), all members of a consolidated group are treated as a single taxpayer." Prop. Reg. § 1.1502-59A(b)(1). Prop. Reg. § 1.59A-5 provides rules regarding the calculation of the base erosion minimum tax amount, which depends, in part, on MTI. The calculation of MTI is set forth in Prop. Reg § 1.59A-4(b), which provides that MTI is "a taxpayer's taxable income, as defined in section 63(a)."

The proposed regulations, however, appear to invoke regulatory authority under section 59A(i) to propose regulations that depart from the statute in the computation of MTI by adopting an add-back approach rather than a recomputation approach. The Preamble explains that the rationale for the departure from the statute is simplification (recomputation would require tracking of attributes) and ease of NOL and section 163(j) computations. The Preamble at 83 Fed. Reg. 65,965 specifically states that:

The proposed regulations do not provide for the recomputation of income under an approach similar to the alternative minimum tax, which the Act repealed for corporations. See section 12001(a) of the Act. Under a recomputation approach, attributes that are limited based on taxable income would be subject to different annual limitations, and those attributes would have to be re-computed for purposes of section 59A. Applying this approach in a manner that reflects the results of the BEAT-basis recomputation to subsequent years would lead to parallel attributes that are maintained separately in a manner similar to the pre-Act corporate alternative minimum tax. For example, the amount of the net operating loss used to reduce modified taxable income would differ from the amount used in computing regular tax liability, and the carryforward of unused net operating loss that is used to compute regular tax liability would not reflect the net operating loss amount used to reduce modified taxable income (absent a separate BEAT-basis carryover.). . . .Consequently, the add-back approach also provides simplification relative to the recomputation approach because the add-back approach eliminates the need to engage in the more complex tracking of separate attributes on a BEAT basis in a manner similar to the repealed corporate AMT. The Treasury Department and the IRS welcome comments on the add-back approach provided in the proposed regulations, and the practical effects of an alternative recomputation-based approach.

Under the single taxpayer and add-back approaches, the general rule is that consolidated regular taxable income is computed and then the sum of base erosion tax benefits and the base erosion percentage of consolidated NOLs of all members are added to consolidated taxable income to arrive at a single MTI. Prop. Reg. § 1.1502-59A(b). The Preamble contemplates that the add-back will begin with negative regular taxable income where deductions (other than deductions for NOL carryforwards or carrybacks) cause regular taxable income to be negative. The Preamble states, "Generally, the proposed regulations provide that a negative amount is the starting point for computing modified taxable income when there is no NOL deduction from net operating loss carryovers and carrybacks." Preamble, at 83 Fed. Reg. 65,965. Thus, consistent with the statute, the proposed regulations allow a negative starting point for the computation of MTI when current year deductions exceed gross income.

By contrast, the proposed regulations appear to invoke the regulatory authority under section 59A(i) to reduce otherwise allowable deductions for NOL carryforwards or carrybacks in MTI to the extent NOLs would cause or increase negative taxable income. Prop. Reg. § 1.59A-4(b)(1) states that "the taxpayer's taxable income may not be reduced to an amount less than zero as a result of a net operating loss deduction allowed under section 172." See also Prop. Reg. § 1.59A-4(b)(2)(ii) (stating that "[f]or purposes of determining modified taxable income, the net operating loss deduction allowed does not exceed taxable income before taking into account the net operating loss deduction"). The Preamble explains the reasons for the rule limiting the NOL deduction as follows:

If a taxpayer has an excess of deductions allowed by Chapter 1 over gross income, computed without regard to the NOL deduction, the taxpayer has negative taxable income for the taxable year. Generally, the proposed regulations provide that a negative amount is the starting point for computing modified taxable income when there is no NOL deduction from net operating loss carryovers and carrybacks.

The proposed regulations further provide a rule applicable to situations in which there is a NOL deduction from a net operating loss carryover or carryback to the taxable year and that NOL deduction exceeds the amount of positive taxable income before that deduction (because, for example, the loss arose in a year beginning before January 1, 2018). The proposed regulations provide that the excess amount of NOL deduction does not reduce taxable income below zero for determining the starting point for computing modified taxable income. The Treasury Department and the IRS have determined that this rule is necessary because section 172(a) could be read to provide that, for example, if a taxpayer has a net operating loss of $10Ox that arose in a taxable year beginning before January 1, 2018, that is carried forward, and in a subsequent year the taxpayer has taxable income of $5x before taking into account the $10Ox net operating loss carryover deduction, the taxpayer may nonetheless have a $100x NOL deduction in that year or a $95x taxable loss (even though $95x of the net operating loss would remain as a carryforward to future years, as well). Because the proposed regulations recognize the notion of a taxable loss when deductions other than the NOL deduction exceed gross income (as discussed earlier in this Part V), this rule clarifies that the taxpayer's starting point for computing modified taxable income in this situation is zero, rather than negative $95x.

The proposed regulations further clarify that the NOL deduction taken into account for purposes of adding the base erosion percentage of the NOL deduction to taxable income under section 59A(c)(1)(B) is determined in the same manner. Accordingly, in the example above, the base erosion percentage of the NOL deduction added to taxable income is computed based on the $5x NOL deduction that reduces regular taxable income to zero, rather than the entire $10Ox of net operating loss carryforward, $95x of which is not absorbed in the current taxable year.

Preamble, at 83 Fed. Reg. 65,965-66. The special NOL rule appears to be intended to prevent NOL carryovers that can cause or increase negative taxable income from reducing MTI in multiple years.

The Preamble does not address how the rules for computing MTI under the proposed regulations that depart from the statute interact with the current subgroup approach of life/nonlife consolidation, including, for example, P&C company NOL carrybacks that can offset 100 percent of regular taxable income and bump life subgroup NOLs that may be subject to the 80-percent limitation.⁴

Life/Nonlife Regulations under Treas. Reg. § 1.1502-47

Special rules apply under Treas. Reg. § 1.1502-47 to taxpayers that elect to file a life/nonlife consolidated return. These rules require the use of a subgroup method to determine consolidated taxable income, with one subgroup consisting of the group's nonlife companies and the other subgroup consisting of the group's life insurance companies. Treas. Reg. § 1.1502-47(a)(2)(i). In general, and except to the extent the life/nonlife consolidated rules provide otherwise, all of the other consolidated return provisions apply. Treas. Reg. § 1.1502-47(a)(4).

Initially, each subgroup computes its consolidated taxable income by applying the rules in Treas. Reg. § 1.1502-11. The nonlife subgroup computes nonlife consolidated taxable income and the life subgroup computes consolidated partial life insurance company taxable income. Treas. Reg. § 1.1502-47(a)(2)(i). As part of that calculation, each subgroup is required to use its own NOL carryforward or carryback determined as if the subgroup was the consolidated group. See Treas. Reg. § 1.1502-47(h)(2)(iv), (k)(5), (1)(3). This treatment is required even if the other subgroup has a current year loss. See, e.g., Treas. Reg. § 1.1502-47(h)(2)(iii) and (v), (k)(5)(i) and (ii). If a subgroup's NOL carryforward is insufficient to absorb that subgroup's taxable income, a current year loss from the other subgroup may generally be utilized. However, losses from the nonlife subgroup are limited in absorbing life subgroup income under sections 1503(c)(1) and (2). If the current year loss is insufficient to absorb any remaining taxable income, the NOL carryforward of the other subgroup may be used, although similarly the use of nonlife losses against life subgroup income continue to be limited. Section 1503(c) does not contain limitations on the use of life subgroup losses against nonlife subgroup taxable income.

Consequently, even though under Treas. Reg. § 1.1502-47 one subgroup's taxable income before consolidation may generally be netted against another subgroup's taxable loss, in whole or in part, in computing overall consolidated taxable income, the life/nonlife consolidated return rules adopt unique rules that treat this sharing as an offset by a loss of the other subgroup, rather than a pure consolidated taxable income calculation of a consolidated group that is treated as a single taxpayer. Unlike the rules for other consolidated return filers, in the case of a life/nonlife group filing, the deductions and income of a subgroup with a taxable loss do not actually affect the computation of nonlife consolidated taxable income or consolidated partial life insurance company taxable income. Treas. Reg. § 1.1502-47(a)(2)(ii). Rather, it constitutes a bottom-line adjustment in reaching consolidated taxable income. Because of these unique rules and the treatment of losses as offsets rather than part of a single consolidated taxable income calculation, consolidated taxable income as defined in Treas. Reg. § 1.1502-47(g) cannot be a negative number except in a subgroup partial calculation.

We anticipate that amendments will be proposed to the subgroup approach in Treas. Reg. § 1.1502-47 as a result of the amendments to section 172. Section 172 provides that, unlike other types of taxpayers, P&C companies can carryback NOLs to two prior taxable years and offset 100 percent of certain taxable income. In addition, several aspects of the subgroup approach of Treas. Reg. § 1.1502-47 are outmoded and need to be updated to be more consistent with overall consolidated return principles to the extent not inconsistent with the statutory limitations in section 1503(c) (e.g., an update is needed for consolidated capital gains/losses). At this time, there is no guidance as to what changes may be made to life/nonlife consolidation and how they may affect MTI and BEAT.

II. DISCUSSION OF LIFE/NONLIFE PROBLEMS
IN PROPOSED REGULATIONS

The proposed regulations and Preamble do not address how the departures from the statute in computing MTI apply to life/nonlife consolidated returns, although presumably they assume that the add-back approach to compute MTI will be at the overall consolidated taxable income level. Such an interpretation leads to multiple interpretive issues in applying the subgroup approach to life/nonlife consolidation. The single-taxpayer approach for computing MTI within a consolidated nonlife return or a life/life consolidated return works in a year in which the deductions of the loss members exceed the income of the profitable members to produce negative taxable income as contemplated and sanctioned in the proposed regulations. This simplified convention is problematic, however, in the life/nonlife context because the consolidated taxable income of a life/nonlife subgroup cannot be negative even if each subgroup has current year deductions that exceed its gross income. In addition, current period losses of the life members are not combined against the current income of the nonlife members until after a subgroup computation and the application of the unique current period loss absorption rules. A group can only determine negative current taxable income within a subgroup computation. Preventing a life/nonlife consolidated group from using negative taxable income as a starting point for computing MTI is inappropriate and presumably not intended — a taxpayer should not be treated more harshly under section 59A because it files a life/nonlife consolidated return. "In developing these proposed regulations, the Treasury Department and the IRS have generally aimed to apply the principle that an economically efficient tax system would treat income derived from similar economic decisions similarly, to the extent consistent with the statute and considerations of administrability of the tax system." Preamble, at 83 Fed. Reg. 65,974.

Prior to the issuance of the proposed regulations, taxpayers that have filed life/nonlife consolidated returns reasonably relied on the recomputation approach of computing MTI in section 59A(c) in applying Treas. Reg. § 1.1502-47. In doing so, each subgroup's consolidated taxable income is recomputed without regard to base erosion tax benefits or the base erosion percentage of NOLs, and only after these subgroup calculations are made and combined is the overall single taxpayer MTI determined. Under such approach required by the statute and current Treas. Reg. § 1.1502-47, current year losses in each subgroup can be taken into account and NOLs can cause or increase negative taxable income in each subgroup. In arranging their business activities in response to the enactment of BEAT, taxpayers reasonably relied in good faith on section 59A(c), section 172, and Treas. Reg. § 1.1502-47 and cannot be expected to have anticipated an exercise of regulatory authority under section 59A(i) with retroactive effect that extends beyond abusive transactions. Retroactive application of regulations in these circumstances is not "necessary or appropriate" to carry out the BEAT provisions.

Recommendation

We respectfully request that the final regulations provide an election to taxpayers who filed a life/nonlife consolidated return for the taxable year ending December 31, 2017, to follow the statute in calculating MTI (i.e., use a recomputation approach and allow NOLs to cause or increase negative taxable income) rather than the alternate rules in the proposed (or final) regulations, as long as the taxpayer adopts a reasonable and consistent method to track the use of NOL carryforwards and carrybacks taken into account in determining MTI to avoid any NOL double counting in MTI in subsequent years. The election could be limited so that it is only applicable for taxable periods beginning before (i) new rules promulgated under section 59A that specifically take into account the unique subgroup approach to life/nonlife consolidation are generally applicable, or (ii) taxable years ending after December 31, 2019, whichever is later.

We believe such a limited election would allow a taxpayer filing a life/nonlife consolidated return during a brief transition period to begin the calculation of MTI at the subgroup level. It is at that level that (1) the initial computation of consolidated taxable income under Treas. Reg. § 1.1502-11 is determined, (2) regular taxable income in the current year can be negative, and (3) NOL carryforwards or carrybacks are used and can result in negative taxable income. That is, under the statute, NOL carryforwards or carrybacks in a life/nonlife consolidated return can give rise to negative taxable income in a subgroup and then appropriately be taken into account in determining MTI. In computing MTI under section 59A(c) (as a result of the election), for example, a nonlife subgroup should be able to take into account any remaining "negative" amount in the life subgroup (i.e., the life subgroup's negative taxable income after elimination of any base erosion tax benefit with respect to any base erosion payment) in determining MTI for the life/nonlife consolidated group. To the extent this approach might otherwise result in double counting of NOLs in MTI in multiple years, the limited transition-period election could be conditioned on the taxpayer's adoption of a reasonable and consistent method to track, and exclude from MTI, any NOLs that have already been taken into account in determining MTI for another year.

We appreciate the opportunity to provide these comments on the proposed regulations.

Respectfully submitted,

Lori Jones
Scribner, Hall & Thompson, LLP
Washington, DC