Pension Investment Board Concerned With BEAT Aggregation Rules

September 4, 2018

Mr. David J. Kautter
Assistant Secretary (Tax Policy)
Acting Commissioner of the Internal Revenue Service
U.S. Department of Treasury
1500 Pennsylvania Ave., NW, Room 3058
Washington, DC 20220

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

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

Mr. William M. Paul
Acting Chief Counsel
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224

Re: Comments on Section 59A of the Internal Revenue Code, Section 14407 of the Tax Cuts and lobs Act of 2077

We welcome the opportunity to provide written comments on recently enacted section 59A of the Internal Revenue Code. Section 59A contains the Base Erosion and Anti-Abuse Tax, or “BEAT.” We are specifically concerned that the aggregation rules of section 59A(e), as applied to large institutional investors such as ourselves that have majority investments in a number of portfolio companies, will prove unworkable without regulatory adjustments. It is not uncommon for such large institutional investors to hold majority stakes in several investee companies that have little to no relation whatsoever with one another, but for their ultimate common ownership by such investors. Nevertheless, absent regulatory relief, such portfolio companies would be aggregated with each other for purposes of determining whether the $500 million gross receipts test and base erosion percentage threshold are met for purposes of the “applicable taxpayer” definition relevant to section 59A.

Because such a broad application of the aggregation rule will have distortive, unpredictable and likely unintended effects (while proving difficult to administer for institutional investors), we recommend that regulations provide that, for purposes of applying section 59A(e), otherwise unconnected portfolio companies ultimately owned by institutional investors not be aggregated. For this purpose, we recommend that institutional investors (and, at a minimum, a foreign government as defined under section 892 and the regulations thereunder that is not itself engaged in any commercial activity) not be included in the types of entities that can lead to aggregation. This exclusion may be provided, for example, by treating such institutional investor as a shareholder other than a corporation or trust for purposes of either section 52(a) (referring to the single employer rule) or 1563(a) (referring to the controlled group).

Absent regulatory relief, we respectfully submit that institutional investors otherwise treated as corporations or trusts for U.S. federal income tax purposes would face undue BEAT exposure on their majority owned portfolio investments. We understand that this result was not the contemplated or intended legislative result from enacting the BEAT. Rather, the BEAT aims to prevent undue base erosion by multinational enterprises (“MNEs”). Such MNEs may have multiple U.S. entities in their groups held in various silos under a single parent company, and all these entities are part of a unitary business. However, the same considerations are not present with institutional investors, which may acquire multiple disparate investee companies that have no strategic relationship to each other. Thus, requiring aggregation for purposes of determining a group's gross receipts and base erosion percentage is not only unnecessary to prevent manipulation of the BEAT rules, but also is likely to distort how BEAT should properly apply to the investee companies. Moreover, these institutional investors would be at a disadvantage in comparison to private equity and other fund investors that primarily operate in partnership form in regard to their BEAT exposure.

PSP Investments

The Public Sector Pension Investment Board (“PSP Investments”) is one of Canada's largest public pension plan investment managers, with approximately CAD 153 billion of net assets under management (“AUM”) as of March 31, 2018. Specifically, PSP Investments invests funds for the pension plans of the Public Service, the Canadian Forces, the Royal Canadian Mounted Police and the Reserve Force, in the best interests of contributors and beneficiaries.

PSP Investments is a global investor across a wide array of asset classes including infrastructure, real estate, natural resources, public markets and private equity. Its total U.S. investments have increased considerably over the past several years, and currently amount to more than CAD 59 billion. This represents 39% of its total AUM.

PSP Investments' private market portfolio includes majority investments in several companies that have U.S. operations. Each of these portfolio companies is independent of the others and each is only connected to the others through PSP Investments, as a majority owner in each of the companies. These portfolio companies are diverse in nature and operate in different industries and business sectors; they are not integrated business operations.

As described above, PSP Investments operates as a pension investment manager to ensure responsible investment among a diverse asset portfolio to build growth for its public pension plan beneficiaries. It is only in its capacity as an investment manager and due to its significant AUM that PSP Investments is able to make large-scale investments in alternative assets. While PSP Investments' investment strategy includes the acquisition of majority stakes in certain portfolio companies, it does not operate the underlying businesses, which operations are left to management teams that are employed by these portfolio companies. Rather, PSP Investments' objective is to generate a sustainable rate of investor return from these underlying portfolio company investments both during the holding period and on exit. This characteristic, which is common to other institutional investors, is fundamentally different than that of a multinational group of companies that acquires companies that strategically fit into its business portfolio and acquires such companies to operate them. In addition, while MNEs operate and manage their business portfolio as an integrated one, institutional investors are not integrated in this way, as each portfolio company is operated by different, separate and unconnected management teams, and the companies are assessed independently from one another.

Because institutional investors' (such as PSP Investments') relationships to their underlying investments are, as described above, different from the relationship of MNEs to their subsidiaries, applying the aggregation rules to such investors would not be appropriate in light of the intended focus of the BEAT provision. While we do not think that it would be appropriate to apply the aggregation rule under section 59A(e) to institutional investors and their portfolio companies that would not otherwise have any strategic business relationship to each other, we do believe that any portfolio company owned by an institutional investor should remain subject to BEAT if it exceeds the gross receipts and base erosion percentage thresholds (including by reason of applying the aggregation rule to affiliates of the portfolio company).

Section 59A(e) Aggregation Rule

Section 59A requires each corporation that is treated as an applicable taxpayer to calculate a minimum tax amount. While the tax liability under section 59A is computed on a taxpayer by taxpayer basis, section 59A(e) requires that multiple taxpayers be aggregated for certain purposes.

Section 59A applies only to corporate taxpayers that have an average annual gross receipts for the preceding three taxable years of at least $500 million and that have a “base erosion percentage” of at least three percent (in some cases, two percent). For purposes of making these two determinations, section 59A(e) provides that entities that are treated as a single employer under section 52(a) are aggregated. Moreover, if section 59A applies to a taxpayer, in calculating that taxpayer's minimum tax, it must adjust its taxable income without regard to the base erosion percentage of any net operating losses utilized in the relevant tax year. Section 59A(e) provides that the aggregation rule applies for purposes of calculating the taxpayer's base erosion percentage. This means that a series of corporations that are connected through ownership will be treated as a single employer under section 52(a) and have a single group-wide base erosion percentage.

Section 52(a), which cross-references section 1563 (with certain modifications), provides rules that would treat multiple entities as a single taxpayer in the case of a parent-subsidiary group, a brother-sister group, and a combined group. These rules would treat two corporations as a single taxpayer where both are majority owned, directly or indirectly, by another corporation (or by five or fewer trusts).

Large institutional investors frequently take majority stakes in multiple companies. These companies may not have any relationship with or to one another aside from their common ownership by the same investor. They are not part of a unitary business, and their base erosion profiles may be vastly different.

For example, an institutional investor such as PSP Investments may have a 51 percent stake in a real estate investment group and a 51 percent stake in a clothing retailer and may use a single corporate vehicle to hold both investments. In such a case, section 59A(e) could aggregate the real estate investment group, the clothing retailer, and the investment vehicle for purposes of applying the $500 million gross receipts test and calculating a blended base erosion percentage applicable to both the real estate investment group and the clothing retailer. Calculating such a blended base erosion percentage may have the effect of artificially inflating the base erosion percentage of one group while at the same time artificially deflating that of the other group.

Further, assume the real estate investment group is leveraged and makes considerable base erosion payments. The clothing retailer, on the other hand, does not make any base erosion payments but has considerable net operating losses. As a result of the section 59A(e) aggregation rule, the clothing retailer may be subject to section 59A simply because both entities are owned by the institutional investor, and would need to compute its modified taxable income without regard to a portion of its net operating loss deduction. Contrast this result with the result that would be obtained if the two entities are not aggregated with each other. The clothing retailer, on a standalone basis, makes no base erosion payments and would have a base erosion percentage of zero, and therefore would not be an applicable taxpayer.

Application to Institutional Investors

Section 59A applies only to entities treated as corporations. As discussed above, the aggregation rules apply where two corporations are majority owned by another corporation, or are majority owned by 5 or fewer individuals, estates, or trusts. Thus, if two corporations are both majority owned by the same partnership, they are generally not aggregated, unless either a single corporation or a combination of 5 or fewer individuals, estates or trusts owns a majority interest in the partnership.

Because private equity funds typically hold portfolio companies through partnerships, and it is rare that a single corporation or a combination of 5 or fewer individuals, estates or trusts would hold a majority interest in such partnerships, the aggregation rules typically do not apply to aggregate their U.S. portfolio companies, a result that we believe is both intended and appropriate to private equity funds, as they, like institutional investors, generally do not seek to acquire companies as part of a single, strategically unified, group of companies. However, PSP Investments is an entity described in section 892 as a controlled entity of a foreign government. Because foreign governments and entities wholly owned by foreign governments (including certain pension funds) are treated as corporations for U.S. federal income tax purposes under section 892(a)(3) and Treas. Reg. § 301.7701-2(b)(6),¹ PSP Investments and other similar foreign governmental entities are subject to the aggregation rules with respect to their U.S. portfolio companies in a manner similar to foreign MNEs, and different from the rules that may apply to private equity investors based on how such investors typically hold their investments.

The BEAT aggregation rules were clearly written by Congress with traditional multinational enterprises in mind.² While these multinationals may have multiple U.S. entities in their groups that are held in various silos under a single U.S. or foreign parent company, all these entities are part of a unitary business, and new entities acquired by the group are strategic acquisitions that fit into the overall business of the group, with common mind and management. In such a case, aggregating the various entities within the group for purposes of applying BEAT makes sense because it prevents the group from potentially circumventing the application of section 59A.

The same considerations are not present where multiple disparate investee companies are majority owned by the same institutional investor, including a pension fund or government, organized or treated as a corporation or a trust. Instead, requiring aggregation for purposes of determining the group's gross receipts and base erosion percentage is not only unnecessary to prevent manipulation of the BEAT rules, but also is likely to have a distortive effect on applying BEAT to the investee companies.

Request for Requlatory Relief

We recommend that regulations should provide that the aggregation rules not apply to portfolio investments of large institutional investors and accordingly recommend that such institutional investors not be treated as shareholders of a corporation for purposes of applying the section 59A(e) aggregation rules (which themselves apply the rules of sections 52(a) and 1563 with certain modifications). Regulations should provide for a definition of an institutional shareholder that includes any entity or arrangement that is treated as a foreign government under section 892 and the regulations thereunder (i.e., integral parts of a foreign government, as well as its controlled entities). Section 892(a)(3) provides that a foreign government is treated as a “corporate resident” of its country. However, the legislative history of section 892(a)(3) makes clear that the reason for treating foreign governments as “corporate residents” was directed at enabling governments to qualify as residents of their countries for purposes of applying the benefits of income tax treaties.³ Moreover, section 59A(i) gives Treasury broad authority to issue regulations as “necessary or appropriate” to carry out the provisions of section 59A.

The aggregation rules should continue to apply to any entities in which an institutional investor (including a section 892 investor such as PSP Investments) holds a majority stake underneath a single U.S. corporation. Aggregation would not apply only where portfolio investments are held directly by the applicable institutional investor (in the case of an institutional investor that is a foreign government, aggregation would be cut off only where portfolio investments are held by a controlled entity or integral part of the government).

Each U.S. single investee company held in this way would thus calculate its own base erosion percentage — aggregated with any other entities within its group, but not aggregated with other entities that the institutional investor owns. Our suggested approach also makes sense from a BEAT policy perspective. Where a foreign institutional investor owns U.S. controlled portfolio companies directly, rather than through a U.S. holding corporation, the only common ownership is through the foreign parent, which cannot itself have a base erosion percentage if it does not have effectively connected income. As discussed, unlike a traditional MNE, where the foreign parent functions as a parent of a strategically unified group of companies — so that aggregating makes sense because there could otherwise be an incentive and opportunity to manipulate the base erosion percentage — an institutional investor functions merely as an investor in multiple disparate companies whose businesses are not strategically linked to each other, and therefore there is neither an incentive nor the same opportunity to manipulate the base erosion percentage.

Similarly, regulations should provide that 'institutional investors' for this purpose include pension funds, so that they are also not treated as corporations for purposes of the aggregation rules, even if otherwise organized as corporations or trusts for U.S. federal income tax purposes. Regulations could cross-reference the definition of a qualified foreign pension fund under section 897(l) for purposes of limiting the types of entities that are subject to the aggregation rule.

We appreciate the opportunity to comment on section 59A and wish to contribute to identifying appropriate solutions. Please do not hesitate to contact us if you have any questions or comments regarding our submission.

Sincerely,

Jean-François Ratté
Vice President and Head of Taxation
PSP Investments
Montréal, Québec

CC:
Ms. Marjorie Rollinson
Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, DC 20224

Mr. Robert Wellen
Associate Chief Counsel (Corporate)
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, DC 20224

Mr. Daniel McCall
Deputy Associate Chief Counsel (International-Technical)
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, DC 20224