Treasury Asked to Apply BEAT Computation on Aggregate Basis

Application of the Base Erosion and Anti-Abuse Tax Computation on an Aggregate Basis

September 7, 2018

I. Request

For purposes of determining the scope of an “applicable taxpayer” under section 59A(e)(1), the aggregation rules of section 59A(e)(3) treat all persons who would be treated as a single employer under section 52(a) as 1 person “for purposes of this subsection and subsection (c)(4).” On its face, two readings of the statute are plausible. Under a narrow reading, the aggregation rules are meant to apply only for purposes of section 59A(e)(3) and section 59A(c)(4). In contrast, a broad reading would construe the “applicable taxpayer” definition (determined by applying the aggregation rules) to apply to all portions of the statute unless otherwise indicated. The narrow approach would result in the computation of the base erosion minimum tax amount under section 59A(b) (including the computation of modified taxable income (“MTI”) found in section 59A(c)) on a separate taxpayer basis. In contrast, the broad approach treats the separate taxpayers within an expanded applicable taxpayer group as a single economic unit for purposes of computing the base erosion minimum tax amount (including MTI).

Although some ambiguity exists, for each of the reasons stated below, we think the broad aggregate approach is more clearly supported by the statutory language and legislative history and would result in a more balanced application of the statute in an internally consistent manner. This result could be achieved by promulgating regulations indicating that section 59A is to be applied on an aggregate basis, where the computation of the base erosion minimum tax amount included in section 59A(b) is to be determined by treating all taxpayers forming part of the “applicable taxpayer,” as defined in section 59A(e), as one taxpayer.

Further, the aggregate approach should not give rise to elimination of any base erosion payments within the aggregate group, as discussed below, and is not inconsistent with Congressional intent to impose a different tax rate (as provided in section 59A(b)(3)) to an affiliated group (as defined in section 1504(a)(1)) that includes a bank or a registered securities dealer (as further defined in section 59A(b)(3)(B)).

The Secretary of Treasury (“Treasury”) has a broad authority to prescribe interpretative regulations under section 7805 that would clear the ambiguity found in section 59A. Following the broad approach suggested below in regulations would be equitable and lead to a reasoned interpretation that is consistent with the Congressional intent stated in legislative history.

II. Background

Effective January 1, 2018, the Tax Cuts and Jobs Act of 2017 established the Base Erosion and Anti-Abuse Tax (“BEAT”) in section 59A of the Code. A key policy reason behind passing the BEAT was to impose a minimum tax on related groups of US corporations (and US branches of foreign corporations) that take a disproportionately high amount of US tax deductions on payments to a foreign related party in relation to the overall economic features of the group.

Section 59A(a) imposes on each applicable taxpayer a tax equal to the base erosion minimum tax amount for the taxable year. For purposes of determining the applicability of the BEAT, section 59A(e)(1) provides generally that the term “applicable taxpayer” includes a corporation (other than a regulated investment company, a real estate investment trust or an S-corporation), with (1) $500,000,000 or more in average annual gross receipts over the prior 3 taxable years, and (2) with a base erosion percentage (as determined under section 59A(c)(4)) of 3% or higher (or 2% for an affiliated group which includes a bank or registered securities dealer, as described in section 59A(b)(3)(B)).

The aggregation rules of section 59A(e)(3) apply for purposes of defining an “applicable taxpayer.” These aggregation rules provide generally that all persons treated as a single employer under section 52(a) are treated as one person, except that in applying section 1563 for purposes of section 52, the exception for foreign corporations under section 1563(b)(2)(C) is disregarded.

Section 59A(e)(3) further provides that the aggregation rules apply for purposes of determining the base erosion percentage (determined under section 59A(c)(4)). The “base erosion percentage” is generally defined to mean the aggregate amount of the taxpayer's base erosion tax benefits for the taxable year divided by the sum of the aggregate amount of certain deductions allowable to the taxpayer for that year.

In general, the computational impact of the BEAT is determined by comparing the taxpayer's regular tax liability (as defined in section 26(b) with certain modifications required in section 59A(b)(1)(B)) to its MTI calculated in accordance with section 59A(c) and multiplied by the applicable percentage for that year (e.g., 5% in 2018 and 10% in 2019-2025). Section 59A(c)(1) defines the term “modified taxable income” to mean “the taxable income of the taxpayer computed under this chapter 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.”

III. Scope of Aggregation Rules

While section 59A clearly employs the aggregation rules for purposes of determining an “applicable taxpayer” under section 59A(e)(1) and the taxpayer's “base erosion percentage” for purposes of section 59A(c)(4), the statute is ambiguous as to whether the base erosion minimum tax amount and MTI are meant to be computed on an aggregated or a separate taxpayer basis under sections 59A(b)(1) and 59A(c). Although the language of the statute could infer a separate taxpayer reading in several places, the better reading of the statute is that the base erosion minimum tax amount and MTI are computed on an aggregate taxpayer basis.

Because section 59A is ambiguous and it is unclear whether the base erosion minimum tax amount and MTI should be computed on an aggregate or separate taxpayer basis, Treasury should use its broad authority under sections 7805(a) and (c) to prescribe rules and regulations that would clarify, interpret, and explain the basis on which such computations should be done.¹ Such interpretative regulations would “reconcile the ambiguities in the statute with a reasoned interpretation.”² The courts have generally upheld interpretative regulations unless they found them to be “unreasonable and plainly inconsistent with the revenue statutes.”³

A. Limitations of a Separate Taxpayer Approach

Some evidence exists to support a reading of sections 59A(b)(1) and 59A(c) that would infer the computation of the base erosion minimum tax amount and MTI on a separate taxpayer basis. Notably, the fact that section 59A(e) defines applicable taxpayer “for purposes of this section” and cross references section 59A(c)(4) could support a narrow reading of the statute such that the aggregation rules work only to define an “applicable taxpayer” for purposes of applying the BEAT threshold tests in section 59A(e) and the base erosion percentage in section 59A(c)(4), as needed to apply these tests in section 59A(e). Lending further credence to this line of argument is the fact that section 59A(a) imposes the BEAT tax on “each applicable taxpayer” and that section 59A(b)(1) defines the base erosion minimum tax amount with respect to “any applicable taxpayer.” In this context, the use of the words “each” and “any” could indicate that the computational portions of the BEAT are intended to apply on a separate taxpayer basis. It could further be argued that since section 59A(c) uses the word “taxpayer” instead of “applicable taxpayer,” this distinction is an expression of Congressional intent that sections 59A(b)(1) and 59A(c) are not meant to apply on an aggregated taxpayer basis. Finally, another ambiguity is that the determination of regular tax liability, as defined in section 26(b), suggests that the computation of the base erosion minimum tax amount under section 59A(b) is to be done on a separate taxpayer basis.

B. The Aggregate Approach is More Consistent with the Language of Section 59A and with the Purpose of the BEAT

However, considering the weight of the evidence, the stronger reading is that the aggregation rules apply to all parts of section 59A, including the computation of base erosion minimum tax amount of section 59A(b)(1) and the computation of MTI under section 59A(c). For example, page 530 of the Joint Explanatory Statement of the Committee of Conference (“Joint Explanatory Statement”) clearly reflects the legislative intent behind the aggregation rules as follows:

Additionally, with regard to the section 59A(c)(1) reference to the “taxpayer” rather than to the “applicable taxpayer,” the legislative history strongly suggests that the use of this verbiage in the statute does not intend to “turn off” the aggregation rules for purposes of applying section 59A(c).

In particular, the full import of Congress' intent is made clear on page 528 of the Joint Explanatory Statement, which provides:

Furthermore, although the split approach of (1) treating related consolidated groups, corporations and branches as a single economic unit for purposes of applying the threshold requirements of the BEAT (section 59A(e)) but (2) as separate units for purposes of determining the section 59A computational impact may be beneficial to some taxpayers, the majority of situations that we have considered under such a split approach would be detrimental to most taxpayers. We believe that an approach of treating all group members as a single taxpayer for all purposes of applying section 59A would be a more balanced approach to applying that statute, in an internally consistent manner, without creating a harsher application of these rules than is necessary to achieve its policy objectives. In order to better illustrate these results, we have applied both the aggregate and separate taxpayer readings of the statute to several scenarios illustrated in Appendix 1. In our examples we have used the Add-Back Method to compute MTI, but we note that MTI can be computed by either using the Add-Back or Recomputation methods.

It should be noted that a self-help solution of including all US corporations and branches under a single consolidated group is not available to all. At times, a common parent (whether US or foreign) must have separate US consolidated groups, corporations or branches due to business, regulatory, corporate-organizational and other aspects (such as management, profits and losses considerations) that make physical integration not possible. Further, the aggregate approach more accurately reflects the economics of the group by treating it as a single unit. Regardless of whether the entities are formally treated as an aggregate, they represent a single economic unit where they have a common parent, overall common management, share services and are generally treated as a single employer.

C. The Impacts of the Aggregate Approach can be Determined Fairly and Accurately by Pro Rata Allocation

The effects of the BEAT can easily be allocated pro rata among members of the aggregate applicable taxpayer group. With respect to base erosion payments, net operating losses (“NOLs”) and foreign tax credits (“FTCs”), the impact of the BEAT on each separate taxpayer can be determined proportionally in relation to each separate taxpayer's contribution to the aggregate figures. The base erosion minimum tax amount for each separate taxpayer is readily ascertainable using this pro rata approach. A more detailed example illustrating the application of this pro rata approach is provided in Scenario 5 of Appendix 1.

Furthermore, the pro rata approach is the most accurate way to determine the BEAT percentage imposed in computing the base erosion minimum tax amount (as provided in sections 59A(b)(1)(A) and 59A(b)(3)(A)), i.e., 5% or 6% in 2018 (10% or 11% for 2019-2025) where one or more members of the group are a bank or a registered securities dealer. In such cases, section 59A(b)(3)(A) imposes a higher rate on affiliated groups (as defined in section 1504(a)(1)) which include a bank or a registered securities dealer. Since the section 1504(a)(1) affiliated group is only a subset of the larger aggregate applicable taxpayer group, the use of a pro rata apportionment approach is necessary to track the relative contributions of the section 1504(a) and non-section 1504(a) components of the group and apply the different tax rates to each respective portion, as provided in sections 59A(b)(1)(A) and 59A(b)(3)(A).

The portion of aggregate MTI subject (in 2019-2025) to 10% tax under section 59A(b)(1)(A) (“10% MTI base”) and the portion subject to 11% tax under section 59A(b)(3)(A) (“11% MTI base”) can be determined by allocating pro rata the section 1504(a) and non-section 1504(a) portions of the applicable taxpayer group and computing MTI for each portion by taxable income, base erosion tax benefits and NOL add-back amounts for each component member of the group. Once the 10% and 11% MTI bases are determined, each is compared with the regular tax liability (adjusted as provided in section 59A(b)((1)(B)) that would be imposed on the taxable income associated with each portion of the applicable taxpayer group to determine the 10% and 11% BEAT amounts. The total BEAT amount for the aggregate applicable taxpayer group would then be determined by adding the 10% and 11% BEAT amounts.

As illustrated in Scenario 6 of Appendix 1, the aggregate approach properly reflects the purposes of the statute, not only by separately tracking and applying the different 10% and 11% rates to the respective portion of MTI intended to comprise the base to which each rate applies, but also by apportioning the effects of the BEAT on the amount of NOL add-back, base erosion payments, MTI, and FTCs for each group member.

D. The Aggregate Approach will not Cause Base Erosion Payments to be Eliminated

For purposes of determining the base erosion payments under section 59A(d), the aggregation rules of section 59A(e)(3) do not apply. In particular, section 59A(d)(1) defines the term “base erosion payment” to mean “any amount paid or accrued by the taxpayer to a foreign person which is a related party of the taxpayer and with respect to which a deduction is allowable under this chapter.” The term “foreign person” is defined in section 59A(f) to have the same meaning given to such term by section 6038A(c). Further, the term “related party” is defined separately in section 59A(g). Because the definitions of “foreign person” and “related party” each apply without regard to the section 59A(e)(3) aggregation rules, related foreign persons are not treated as part of a singular “applicable taxpayer” group for the narrow purpose of determining base erosion payments under section 59A(d). Furthermore, the “base erosion tax benefit” as defined in section 59A(c)(2) is calculated with regard to the amount of deductions allowed with respect to base erosion payments. Thus, an aggregate approach will not cause base erosion payments to be eliminated and will not impact the computation of the base erosion tax benefit

E. The Aggregate Approach can be Applied Easily and Consistently to Controlled Groups with less than 100% Ownership

The taxable income of each member of the applicable taxpayer group is included for purposes of computing MTI, regardless of percentage of ownership. Sections 59A(e)(3) and 52(a) adopt a controlled group approach to determining membership in the applicable taxpayer group. These rules apply the controlled group rules in section 1563(a) by substituting 50% for 80% control (by vote or value) and by disregarding the exception for foreign corporations under section 1563(b)(2)(C). For purposes of section 1563(f)(2), stock deemed to be constructively owned by a person by reason of attribution shall be treated as actually owned by such person. For example, a controlled group that consists of a Parent which owns 100% of Sub 1 which in turn owns 51% of Sub 2 would constitute an applicable taxpayer for purposes of section 59A(e)(3). Applying the aggregate approach, all the taxable income of Parent, Sub 1 and Sub 2 should be used to compute the MTI of the applicable taxpayer group. This approach is consistent with the consolidated return regulations applicable to affiliated groups as defined in section 1504(a). Just as an 80%-owned includible corporation would report all of its income on a consolidated return, so too should a 51% controlled member of an applicable taxpayer group include all of its taxable income in the computation of MTI on an aggregate basis.

Although a potential for a vote/value split could result in overlapping controlled groups (within the meaning of section 1563(a)), this issue must be resolved for purposes of determining base erosion percentage under section 59A(c)(4) regardless of whether the aggregate or separate taxpayer approach is adopted and whichever approach is ultimately adopted could be extended to the computation of MTI. For purposes of determining membership in the applicable taxpayer group, section 1563(a) (as made applicable by sections 52(a) and 59A(e)(3)) generally employs a vote or value test for control. Thus, it is possible that two parent entities could split control of a subsidiary with one parent controlling 51% of the subsidiary's voting power and the other controlling 51% of its shares by value. For example, the base erosion percentage computation under section 59A(c)(4) requires computing the aggregate amount of base erosion tax benefits in a group and then dividing that total by the sum of the total deductions and total base erosion tax benefits in the group. This aggregate approach to computing base erosion percentage will apply regardless of whether the aggregate approach applies for purposes of computing MTI. Whichever approach is ultimately adopted to resolve this issue for purposes of section 59A(c)(4) can be easily extended to the computation of MTI.

Finally, it should be noted that the increased (11%) rate applicable to section 1504(a)(1) affiliated groups which contain a bank or registered securities dealer would not be impacted by adopting the aggregate approach. Section 59A(b)(3)(B) explicitly states that this higher rate is applied to an affiliated group under section 1504(a)(1) and not to an applicable taxpayer group determined on a controlled group basis under section 1563. Because this provision applies specifically to affiliated groups with a bank or registered securities dealer member by cross-referencing section 1504(a)(1), section 59A(b)(3)(B) creates a limited exception to the general controlled group rule for purposes of applying the higher rate. Thus, a consolidated group containing a bank or registered securities dealer as a member would not taint other members of the expanded group with a higher rate of tax. Further, because the explicit section 1504(a)(1) reference within section 59A(b)(3)(B) would apply this provision on an affiliated group basis regardless of whether an aggregate or separate taxpayer approach is adopted, the narrow reference to section 1504(a)(1) should have no bearing on whether an aggregate or separate taxpayer approach is used to compute MTI.

IV. The Aggregate Approach Can Be Flexibly Applied

Section 59A(c)(1) defines MTI to mean “taxable income . . . determined without regard to” (1) any base erosion tax benefit with respect to any base erosion payment or (2) the base erosion percentage of any NOL deduction allowed under section 172 for the taxable year (collectively, amounts (1) and (2) are referred to herein as the “BEAT Amounts”). The statute requires clarification as to whether the determination of MTI “without regard to” the BEAT Amounts must be made by starting with the taxpayer's taxable income and then adding back the BEAT Amounts (the “Add-Back Method”) or, alternatively, by recomputing taxable income altogether with the aim of removing any impact of the BEAT Amounts on the overall calculation (the “Recomputation Method”).

Regardless of whether MTI would be computed under the Add-Back Method or the Recomputation Method, either approach should not conflict with the application and implementation of section 59A on an aggregated group basis, because both the Add-Back Method and the Recomputation Method would be applied on a separate taxpayer or consolidated group basis and the MTI of the aggregated group would be the result of adding up (aggregating) items that are already computed on a separate taxpayer or consolidated group basis (e.g., regular tax liability, foreign tax credits utilized, NOL deduction). It is expected that under either approach taken, the amount of the current year operating loss or the NOL deduction of a separate taxpayer or a consolidated group will be taken into account in aggregation only to the extent such current year operating loss or NOL deductions are taken into account at the separate taxpayer or consolidated group level. Scenario 4 of Appendix 1 illustrates this point.

Similarly, the aggregate approach can be applied whether regular taxable income is either a positive or a negative number (either because of a current year operating loss or an NOL carryforward). Finally, great flexibility can be achieved in applying the aggregated group approach by introducing an election allowing individual group members to opt out of the aggregated group for purposes of applying the BEAT due to non-tax considerations (such as minority investors or economic considerations).

V. Computation of Regular Tax Liability as Defined in Section 26(b)

As mentioned above, another ambiguity is that the reference made in section 59A(b)(1)(B) to “regular tax liability (as defined in section 26(b))” suggests that the computation of the base erosion minimum tax amount is to be done on a separate taxpayer basis and may not support an aggregate approach. However, the base erosion minimum tax amount can be computed, as suggested above, by following the aggregate approach without such an approach conflicting with the definition of regular tax liability found in section 26(b).

First, under the above proposed aggregate approach, the aggregate group would compute the regular tax liability (with the required adjustments under section 59A(b)(1)(B)) for each separate taxpayer and/or consolidated group that is a part of the applicable taxpayer's group. Such amount would be computed as otherwise required under Code following the definition in section 26(b) and taking into account any limitation applied on a separate taxpayer and/or a consolidated group basis (e.g., foreign tax credits or loss utilization limitation). Then, the regular tax liability amounts (as adjusted under section 59A(b)(1)(B)) of each separate taxpayer and/or consolidated group that is a part of the applicable taxpayer group are added together to come up with the aggregate section 59A(b)(1)(B) amount.

Second, the aggregate group would compute the MTI under section 59A(c)(1). MTI is computed by adding together the taxable income of each separate taxpayer and/or consolidated group that is a part of the applicable taxpayer group (where MTI is computed by either following the Add-Back Method or the Recomputation Method). The MTI is then multiplied by the applicable tax rate for the taxable year, which is used as the aggregate section 59A(b)(1)(A) amount.

Third, the aggregate section 59A(b)(1)(A) amount is compared to the aggregate section 59A(b)(1)(B) amount, and the excess, if any, is the BEAT amount due by the aggregate group. The aggregate group would then allocate, on a pro rata basis, the BEAT amount to each separate taxpayer and/or consolidated group that is part of the applicable taxpayer group.

This approach respects the computation of regular tax liability as defined in section 26(b), the various limitation requirements of the Code (e.g., loss utilization limitation), and the different tax rate applied to section 59A(b)(3)(B) taxpayers, while providing for an aggregate approach for the computation of the BEAT liability of the group and the allocation of the BEAT amount amongst the separate taxpayers and/or consolidated groups that are part of the applicable taxpayer group.

As mentioned above, this approach would be easy to administer, compute and audit.

VI. Conclusion

Section 59A(i) explicitly grants Treasury the authority to provide interpretive guidance as necessary or appropriate to carry out the provisions of section 59A. Further, Treasury has broad authority to prescribe interpretative regulations under sections 7805(a) and (c) that would clear the ambiguity found in section 59A. Following the broad approach suggested above in regulations would be equitable and lead to a reasoned interpretation that is consistent with the Congressional intent stated in legislative history. Consistent with this grant of legislative authority and as supported by the language of the statute and its legislative history, it would be appropriate for Treasury to issue regulations to indicate that section 59A is to be applied on an aggregate basis, where the computation of the base erosion minimum tax amount included in section 59A(b) is to be determined by treating all taxpayers forming part of the “applicable taxpayer,” as defined in section 59A(e), as one taxpayer. These regulations could provide for a pro rata apportionment rules to allocate the effects of the BEAT across separate group members to effectuate the computation and the different percentages imposed by sections 59A(b)(1)(A) and 59A(b)(3)(A).

Finally, with respect to the computation of MTI under section 59A(c)(1) without regard to any BEAT Amounts, the MTI of the aggregated group can be computed based on the “Add-Back” Method or the “Recomputation” Method. Neither approach should conflict with the application and implementation of section 59A on an aggregated group basis.