Coalition’s Reg Comments Reflect Purpose of BEAT Regime

February 19, 2019

The Honorable Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, DC 20044

Re: Comments on proposed regulations implementing IRC section 59A (NPRM REG-104259-18)

Dear Commissioner Rettig:

The Alliance for Competitive Taxation (“ACT”) is a coalition of leading American companies from a wide range of industries that supports a globally competitive corporate tax system that aligns the United States with other advanced economies.

Attached are ACT's comments on proposed regulations implementing section 59A of the Internal Revenue Code as amended by the Tax Cuts and Jobs Act (“TCJA”). We recognize and commend the extraordinary efforts of Treasury and IRS staff in issuing TCJA guidance in a timely and comprehensive manner.

We appreciate your consideration of these comments. ACT representatives welcome future discussion of these comments with your staff.

Yours sincerely,

Alliance for Competitive Taxation
Washington, DC

cc:
L. G. “Chip” Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury Department
Douglas Poms, International Tax Council, U.S. Treasury Department
Harvey Mogenson, U.S. Treasury Department
Brenda Zent, Special Advisor, U.S. Treasury Department
Leni Perkins, Attorney-Advisor, Branch 8, ACC(I), Internal Revenue Service
Sheila Ramaswamy, Attorney-Advisor, ACC(I), Internal Revenue Service
Karen Walny, Attorney-Advisor, ACC(I), Internal Revenue Service
Julie Wang, Attorney-Advisor, Internal Revenue Service
John P. Stemwedel, Attorney-Advisor, Internal Revenue Service
Kevin Nichols, Attorney-Advisor, U.S. Treasury Department

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COMMENTS BY ALLIANCE FOR COMPETITIVE TAXATION ON
PROPOSED REGULATIONS IMPLEMENTING SECTION 59A

I. INTRODUCTION

This document sets forth ACT's comments on the proposed regulations implementing section 59A of the Internal Revenue Code as amended by the TCJA (NPRM REG-104259-18) (the “Proposed Regulations”). In the following section, the comments are presented in two parts. The first part contains comments on issues that ACT has not previously addressed in its prior submissions to the Treasury and Internal Revenue Service (“IRS”). The second part amplifies comments on high-priority issues addressed in prior submissions where we continue to believe ACT's recommendations reflect good tax policy and Treasury has authority to provide such guidance.

ACT's comments are guided by its understanding of the purposes of the new base erosion and anti-abuse tax (BEAT) regime. ACT understands that the primary purpose of the BEAT regime is to impose a minimum tax on certain deductible cross-border related party payments that are not taxed to the recipient by the United States. ACT does not believe Congress intended BEAT to impose a second level of tax on income already subject to U.S. income taxation. This includes income subject to U.S. tax as effectively connected with the conduct of a trade or business in the United States, subject to gross-basis withholding tax, and subject to U.S. tax under the subpart F or GILTI regimes.

II. COMMENTS RELATING TO CERTAIN ASPECTS OF PROPOSED SECTION 59A REGULATIONS

A. NEW ISSUES

1. Internal dealings of a treaty-eligible entity (Prop. Reg. § 1.59A-3(b)(4)(v)(B))

Proposed Regulations

Prop. Reg. § 1.59A-3(b)(4)(v)(B) provides:

If, pursuant to the terms of an applicable income tax treaty, a foreign corporation determines the profits attributable to a permanent establishment based on the assets used, risks assumed, and functions performed by the permanent establishment, then any deduction attributable to any amount paid or accrued (or treated as paid or accrued) by the permanent establishment to the foreign corporation's home office or to another branch of the foreign corporation (an “internal dealing”) is a base erosion payment to the extent such payment or accrual is described under [Prop. Reg. § 1.59A-3(b)(1)].

Treasury Explanation

The preamble states that the approach in the Proposed Regulations is intended to create parity between deductions for actual regarded payments between two separate corporations (which are subject to section 482) and internal dealings (which are generally priced in a manner consistent with the applicable treaty and, if applicable, the OECD Transfer Pricing Guidelines).¹

ACT Recommendation

ACT recommends that internal dealings be excluded from the definition of base erosion payments.

Reasons for ACT Recommendation

The method of attributing profits to a permanent establishment (“PE”) under an applicable income tax treaty referenced by Prop. Reg. § 1.59A-3(b)(4)(v)(B) is commonly referred to as the Authorized OECD Approach (“AOA”). However, because under U.S. federal income tax rules, internal dealings within a single corporation are generally disregarded, the AOA is limited to the specific purpose of attributing profits to a PE.² The OECD 2010 Report on the Attribution of Profits to Permanent Establishments (the “2010 OECD Report”) emphasizes the limited application of the AOA:³

The hypothesis by which a PE is treated as a functionally separate and independent enterprise is a mere fiction necessary for purposes of determining the business profits of this part of the enterprise under Article 7. The authorised OECD approach should not be viewed as implying that the PE must be treated as a separate enterprise entering into dealings with the rest of the enterprise of which it is a part for purposes of any other provisions of the Convention. (. . .)

In this context, it should be noted that the aim of the authorised OECD approach is not to achieve equality of outcome between a PE and a subsidiary in terms of profits but rather to apply to dealings among separate parts of a single enterprise the same transfer pricing principles that apply to transactions between associated enterprises. (Emphasis added.)

The 2010 OECD Report reiterates that recognizing internal dealings “does not carry wider implications as regards, for example, withholding taxes.”⁴

Similarly, the U.S. Treasury Technical Explanation to the 2006 U.S. Model Tax Treaty provides:⁵

[A]ny of the methods used in the Transfer Pricing Guidelines, including profits methods, may be used as appropriate and in accordance with the Transfer Pricing Guidelines. However, the use of the Transfer Pricing Guidelines applies only for purposes of attributing profits within the legal entity. It does not create legal obligations or other tax consequences that would result from transactions having independent legal significance. (Emphasis added.)

Regulations under other provisions of the Code generally do not recognize internal dealings within a single corporation or taxpayer. Under Prop. Reg. § 1.863-3(h)(3)(iii), for example, “[a]n agreement among QBUs of the same taxpayer to allocate income, gain or loss from transactions with third parties is not a transaction because a taxpayer cannot enter into a contract with itself.”⁶ Similarly, under Treas. Reg. § 1.882-5, interbranch transactions of any type between separate offices or branches of the same taxpayer do not result in the creation of an asset or a liability.⁷ Further, under Treas. Reg. § 1.1503(d)-5(c)(1)(ii), items of income, gain, deduction, and loss that are otherwise disregarded for U.S. tax purposes are not taken into account for determining the income or dual consolidated loss attributable to a separate unit.⁸

Accordingly, treating internal dealings as base erosion payments for BEAT purposes is inconsistent with the limited application of the AOA and contrary to the general U.S. tax principle of disregarding intra-taxpayer transactions.

Moreover, BEAT only applies if there is an amount “paid or accrued.”⁹ Internal dealings, on the other hand, are fictional transactions created for the mere purpose of determining business profits attributable to a PE, and as such, do not produce any payment or accrual. Nothing in section 59A suggests that a base erosion payment may include an amount “deemed” paid or accrued or “treated as” paid or accrued. Subjecting to section 59A hypothetical transactions that do not actually exist is inconsistent with the statutory language of section 59A.

Further, imposing U.S. tax on account of internal dealings under section 59A violates the U.S. income tax treaties that have incorporated the AOA under the business profits article. This is because taxing amounts treated as paid by a U.S. PE to the home office under section 59A conflicts with the treaty exemption from U.S. taxation of these amounts.¹⁰ Absent explicit legislative history or statutory override, existing treaties generally are not abrogated by subsequent laws that come into conflict.¹¹ In enacting section 59A, Congress expressed no intent to override U.S. income tax treaties.¹²

For the above reasons, ACT recommends that internal dealings (within the meaning of Prop. Reg. § 1.59A-3(b)(4)(v)(B)) be excluded from the definition of base erosion payments.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

2. Section 988 losses (Prop. Reg. § 1.59A-3(b)(3)(iv))

Proposed Regulations

Prop. Reg. § 1.59A-3(b)(3)(iv) excludes from the definition of a “base erosion payment” any exchange loss from a section 988 transaction that is an allowable deduction and that results from a payment or accrual by the taxpayer to a foreign related party. The Proposed Regulations further provide that all section 988 losses (both from transactions with foreign related and unrelated parties) are excluded from the denominator when computing the taxpayer's base erosion percentage.¹³ All section 988 gains, however, are included as a gross receipt for purposes of the gross receipts test.¹⁴

Treasury and the IRS requested comments on the treatment of section 988 losses. In particular, they requested comments on whether the rule relating to the exclusion of section 988 losses in the denominator of the base erosion percentage calculation should be limited to transactions with a foreign related party.

Treasury Explanation

The preamble states that Treasury and the IRS have determined that section 988 losses do not present the same base erosion concerns as other types of losses that arise in connection with payments to a foreign related party.¹⁵ The preamble provides no explanation with respect to the exclusion of section 988 losses from the denominator.

ACT Recommendation

ACT recommends that all section 988 losses be included in the denominator for purposes of computing the base erosion percentage. Alternatively, ACT recommends that section 988 losses from transactions with unrelated parties be included in the denominator for purposes of computing the base erosion percentage.

Reasons for ACT Recommendation

We agree with Treasury and the IRS that section 988 losses do not present the same base erosion concerns as other types of losses that arise in connection with payments to foreign related parties. These losses are caused by market fluctuations and are not in the taxpayer's control. Accordingly, we believe that the Proposed Regulations, which exclude section 988 losses from the definition of “base erosion payments,” are appropriate.

The Proposed Regulations, however, exclude all section 988 losses from the denominator. According to the statute, the denominator includes all allowable deductions.¹⁶ Section 988 losses are section 165 deductions.¹⁷ As a matter of statutory mandate, ACT recommends that all section 988 losses be included in the denominator for purposes of computing the base erosion percentage.

Should Treasury and the IRS find that this proposal is too broad based on the exclusion of section 988 transactions from the definition of base erosion payment, ACT recommends that section 988 losses from transactions with unrelated parties be included in the denominator for purposes of computing the base erosion percentage. If the basis for the exclusion of all section 988 losses from the denominator is to create symmetry with the exclusion of related party section 988 losses from the numerator, section 988 losses arising from transactions with unrelated parties do not pose any risk of conflict with the exclusion of section 988 losses from the numerator. Further, these transactions — arm's length with unrelated parties — pose little risk of manipulation.¹⁸

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

3. Qualified derivative payments — securities lending transactions (Prop. Reg. § 1.59A-6(d)(2))

Proposed Regulations

Prop. Reg. § 1.59A-6(d)(2) excludes certain insurance contracts as well as sale-repurchase transactions (i.e., “repos”), securities lending transactions, and substantially similar transactions from the definition of a “derivative.”

Treasury Explanation

The preamble highlights that for U.S. federal income tax purposes, a sale-repurchase transaction that satisfies certain criteria is treated as a secured loan.¹⁹ Under section 59A(h)(3) and (4), payments that would be treated as base erosion payments if not made pursuant to a derivative (such as payment of interest on a loan) are excluded from the definition of a qualified derivative payment.²⁰ Accordingly, the preamble states that sale-repurchase agreements were excluded from the definition of a “derivative.”²¹ The preamble further states that Treasury and the IRS determined that securities lending transactions are economically similar to sale-repurchase agreements, and therefore should be treated similarly.²²

Treasury and the IRS requested comments on whether securities lending and sale-repurchase transactions were properly excluded from the definition of a “derivative,” and whether certain transactions lack a significant financing component such that those transactions should be treated as derivatives for purpose of section 59A(h)(4).²³

ACT Recommendation

ACT recommends that securities lending transactions not be excluded from the definition of a “derivative” under Prop. Reg. § 1.59A-6(d)(2).

Reasons for ACT Recommendation

Sale-repurchase transactions generally are properly treated as debt for U.S. federal income tax purposes, with the interest on such debt representing a base erosion payment. The exclusion of such contracts from the definition of a “derivative” is reasonable.

ACT believes that securities lending transactions are fundamentally different from sale-repurchase transactions, and do not raise base erosion concerns. Therefore, ACT believes that securities lending transactions should not be excluded from the definition of “derivatives” within the meaning of section 59A(h)(4).

As a threshold matter, securities lending transactions and sale-repurchase agreements are entered into for different business reasons. Sale-repurchase agreements are generally entered into to obtain (or provide) secured financing. For example, a bank holding a portfolio of treasuries may enter into a sale-repurchase agreement with a foreign affiliate pursuant to which it transfers the treasuries in exchange for cash and an agreement to “repurchase” the treasuries for a slightly higher amount (reflecting an interest charge) the following day.

Securities lending transactions, on the other hand, are primarily used to facilitate the establishment of short positions. The ability for market participants to borrow securities and establish short positions is of key importance for the proper functioning of the markets, a principle that was acknowledged and supported by Congress with the establishment of section 1058.

For example, in a common fact pattern, a customer of a U.S. bank may want to short stock X, a U.K. stock. The U.S. bank would transact with a U.K. affiliate to borrow the stock from its inventory. The U.S. bank may then lend stock X to its customer, who can sell the stock to establish a short position in stock X.

Because securities lending transactions are commonly entered into to facilitate customer transactions, they do not pose the same base erosion concerns as sale-repurchase transactions.²⁴ That is, the U.S. payor is not unilaterally deciding to execute a trade that would result in the payment of tax deductible amounts to a foreign related party, but rather is frequently executing the transaction pursuant to a trade placed by a customer. Moreover, as depicted in the example above, in many cases the counterparty to the securities lending transaction may be both the securities lender and a securities borrower, and as such may both make and receive payments (in equal amounts). In this case, the transaction does not appear to present a base erosion concern (since the taxpayer has equal amounts of income and deduction). Finally, if in-lieu of payments create base erosion payments, the ability of banks and securities dealers to freely facilitate customer short positions may be impacted. Accordingly, securities lending transactions should be included in the definition of derivatives for purposes of section 59A.²⁵

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

4. Gross receipts and base erosion percentage — members of aggregate group with different taxable years (Prop. Reg. § 1.59A-2(d)(2) and (e)(3)(vii))

Proposed Regulations

Under Prop. Reg. §§ 1.59A-2(d)(2)(i) and (e)(3)(vii)(A), in the case of a taxpayer that has a calendar year and that is a member of an aggregate group, the taxpayer determines its gross receipts and base erosion percentage on the basis of the gross receipts of the aggregate group for the three-fiscal-year period ending with the preceding calendar year and the base erosion percentage for the calendar year without regard to the taxable year of any other member of the aggregate group.

Under Prop. Reg. §§ 1.59A-2(d)(2)(ii) and (e)(3)(vii)(B), in the case of a taxpayer that has a fiscal year and that is a member of an aggregate group, the taxpayer determines its gross receipts and base erosion percentage on the basis of the gross receipts of the aggregate group for the three-fiscal-year period ending with the preceding fiscal year of the corporation and the base erosion percentage for its fiscal year without regard to the taxable year of any other member of the aggregate group.

Treasury Explanation

The preamble explains that the Proposed Regulations adopt this approach to provide certainty for taxpayers and avoid the complexity of a rule that identifies a single taxable year for an aggregate group for purposes of section 59A that may differ from a particular member of the aggregate group's taxable year.²⁶ The preamble further provides that taxpayers may use a reasonable method to determine the gross receipts and base erosion percentage information for the time period of a member of the aggregate group with a different taxable year.²⁷

ACT Recommendation

ACT recommends that gross receipts of an aggregate group and the base erosion percentage be determined by reference to an applicable taxpayer's taxable year and the taxable year of each other member of the aggregate group that ends with or within the applicable taxpayer's taxable year.

Reasons for ACT Recommendation

Prop. Reg. §§ 1.59A-2(d)(2) and (e)(3)(vii) essentially require taxpayers to calculate gross receipts and the base erosion percentage of other members of the same aggregate group that are fiscal year taxpayers as if these other members are calendar year taxpayers, and vice versa. The calculation of the amount of deductions that would have been allowable to an entity had it adopted another tax accounting period, however, would involve significant complexity in many cases because taxpayers often do not post adjusting entries to accounting records on a monthly basis with the same rigor that they would on a quarterly basis (if the company's shares are publicly traded in the United States) or on an annual basis (where the company is privately held). This is also so when one considers that provisions under the Code dealing with the timing of deductions generally apply based on a taxpayer's entire taxable year. Moreover, taxpayers would also have to separately track the “hypothetical” base erosion percentages of other members to ensure that the same deduction is not taken into account in subsequent years' testing.

We believe the practical complexities associated with computing gross receipts and base erosion percentages using taxable years that are not actually used by the taxpayer affected is unnecessary and contrary to the policy expressed in the preamble to provide certainty for taxpayers and avoid complexity. The same complexity created for taxpayers would lead to administrative burdens for the IRS upon examining whether a taxpayer's determination is reasonable.

Congress expressly stated that it intended the BEAT to be administrable.²⁸ Determining the gross receipts of an aggregate group and the base erosion percentage by reference to another aggregate group member's taxable year that ends with or within the testing taxpayer's taxable year provides more certainty and simplicity for both taxpayers and the IRS. This method would make it absolutely clear as to which allowable deductions and gross receipts with respect to another member of the aggregate group are relevant, because each taxpayer in the aggregate group should have a filed tax return from which to extract the amounts required to be computed.

Indeed, the Code contains ample rules dealing with entities with different taxable years that adopt an “end with or within” rule of convenience. One such example can be found in section 951(a)(1)(A), which generally provides that if a foreign corporation is a controlled foreign corporation (“CFC”) at any time during any taxable year, a U.S. shareholder must include in its gross income, for its taxable year “in which or with which such taxable year of the corporation ends,” its pro rata share of the CFC's subpart F income. The same convention is incorporated under section 951A(e)(1), which provides that a U.S. shareholder's pro rata share of a CFC's qualified business asset investment, tested income, and tested loss are determined in the same manner as subpart F income and “taken into account in the taxable year of the [U.S.] shareholder in which or with which the taxable year of the [CFC] ends.” Similarly, under provisions of the recently withdrawn proposed regulations under section 163(j) published in 1991, if members of an affiliated group had different taxable years, then the computations required by section 163(j) were “. . . separately determined for each member on an affiliated group basis by aggregating the relevant items for all group members whose taxable years end with or within the taxable year of the member making the computations.”²⁹ Substantially similar rules were also provided under the expanded affiliated group rules of former section 199.³⁰

For these reasons, ACT recommends that the gross receipts and base erosion percentage be determined by reference to an applicable taxpayer's taxable year and the taxable year of each other member of the aggregate group that ends with or within the applicable taxpayer's taxable year.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

5. Payments for services provided to unrelated parties (Prop. Reg. § 1.59A-3(b)(2)(ii))

Proposed Regulations

Base erosion payments generally include amounts paid or accrued to a foreign related party for services, unless, among other things, the services cost method exception applies.³¹ The Proposed Regulations provide that the amount of any base erosion payment is determined on a gross basis except as otherwise permitted by the Code or regulations.³²

Treasury Explanation

The preamble states that the treatment of a payment as deductible, rather than a reduction in or exclusion from gross income, has federal income tax consequences under section 59A and other provisions of the Code.³³ The preamble states that, in light of the existing law for identifying the beneficial owner of income (including under principal-agent, reimbursement, conduit, or other generally applicable principles), the Proposed Regulations do not provide any specific rules for determining whether a payment is properly characterized as a reduction in or exclusion from gross income rather than a deductible payment for purposes of section 59A.³⁴

ACT Recommendation

ACT recommends that a base erosion payment not include an amount paid or accrued to a foreign related party for services where:

Reasons for ACT Recommendation

ACT believes that a taxpayer should not be treated as making base erosion payments solely because it acts as a “middleman” with respect to services provided directly to unrelated parties by a foreign related party. In this situation, the taxpayer should be treated as effectively passing on to the foreign related party the compensation the taxpayer received from the unrelated party. The recommended rule would thus prevent such a payment from being characterized as a base erosion payment solely because the taxpayer rather than a foreign related party was contractually designated as the initial recipient of payment from the unrelated party.

ACT's recommendation recognizes that many taxpayers have commercial arrangements with third party customers requiring services to be performed by the taxpayer's group outside the United States, but that for business reasons require the third party compensation payments to flow through the U.S. taxpayer. The regulations should not force these taxpayers to undergo the business disruption of restructuring third party contractual arrangements solely to redirect the flow of funds without any change in substance, and for similarly situated taxpayers to suffer adverse consequences where such restructuring is not possible.

ACT's recommendation is narrowly targeted to services provided by foreign related parties directly to (or on behalf of) an unrelated party customer. The recommendation therefore would not open the door for taxpayers to erode the U.S. tax base by arranging for foreign related parties to provide services directly to the taxpayer or other U.S. related parties in exchange for deductible service payments. In addition, ACT's recommendation would ensure that the covered arrangements enhance the U.S. tax base by requiring that the taxpayer retain income from the unrelated party customer after making the service payment to the foreign related party. The recommended rule would thus be consistent with the overall policy of the statute to encourage taxpayers to locate income-generating business activities in the United States rather than foreign locations.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

6. Contract research services (Prop. Reg. § 1.59A-3(b)(3)(i))

Proposed Regulations

Base erosion payments do not include certain amounts paid or accrued for services.³⁵ The Proposed Regulations interpret this exception to apply to the cost component of any amount paid for services that satisfy all but two of the requirements of the section 482 services cost method (SCM) under Treas. Reg. § 1.482-9(b):³⁶

Treasury Explanation

The preamble summarizes the regulation just described and discusses a statutory ambiguity not relevant here that the regulation resolves.

ACT Recommendation

ACT recommends that for purposes of the SCM exception under section 59A, the list of non-qualifying activities at Treas. Reg. § 1.482-9(b)(4) be disregarded. Alternatively, if this recommendation is not accepted, ACT recommends that research, development, and experimentation (“RDE”) activities not be treated as non-qualifying activities.

Reasons for ACT Recommendation

The statute indicates that the SCM exception be available “without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure . . .”³⁷ The statute (and legislative history) does not cite in this regard any provisions of the section 482 regulations in contrast to the proposed section 59A regulations, which cite a single regulation, Treas. Reg. § 1.482-9(b)(5), summarized above. A per-se list of non-qualifying activities for the SCM at Treas. Reg. § 1.482-9(b)(4) immediately precedes Treas. Reg. § 1.482-9(b)(5) in the section 482 regulations.³⁸

ACT believes that the list of non-qualifying activities for the SCM at Treas. Reg. § 1.482-9(b)(4) reflects an IRS view that such activities would never meet the requirement for the exception at Treas. Reg. § 1.482-9(b)(5) that an activity not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure in a business. The non-qualifying activities in the list, such as RDE, obviously make the contributions just noted. Treas. Reg. § 1.482-9(b)(4) and (5) serve the same purpose: to identify services that tend to have higher margins and therefore require a full section 482 analysis.

Inasmuch as the section 59A statute refers to neither regulation but, rather, simply states that the SCM exception will apply under section 59A without regard to the SCM requirement that the services not contribute significantly to fundamental risks of business or success or failure, we believe the best reading of the statute is that the SCM exception applies for section 59A purposes without regard to a service being on the non-qualifying activities list at Treas. Reg. § 1.482-9(b)(4).

If the recommendation to disregard the entire excluded activities list is not accepted, ACT believes that RDE services merit special consideration, in particular if these services are associated with the creation of an intangible asset owned by the U.S. taxpayer. Location of intangible assets in the United States was one of the key policy objectives of the global intangible low-taxed income (“GILTI”) and foreign derived intangible income provisions in TCJA. Treating RDE services as base erosion payments, contrary to Congressional intent, would create an incentive to fund RDE offshore with the resulting intellectual property owned outside the United States.

Regulatory Authority for Recommendation

The excluded activities list is best understood as a per-se list of services that contribute significantly to fundamental risks of business success or failure. Consequently, services listed on the excluded activity list should not be excluded automatically from the SCM exception if they meet the other requirements for eligibility, as the statute waives the requirement that the services not contribute significantly to fundamental risks of business success or failure.

Moreover, Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

B. ISSUES PREVIOUSLY COMMENTED UPON

1. Base erosion payments currently included in the U.S. income tax base (Prop. Reg. § 1.59A-3(b)(3)(iii))

Proposed Regulation

Prop. Reg. § 1.59A-3(b)(3)(iii) provides that a base erosion payment does not include amounts paid or accrued to a foreign related party that are subject to U.S. tax as income effectively connected with the conduct of a trade or business in the United States (“ECI”).³⁹ In the case of a foreign recipient that determines its net U.S. taxable income under an applicable income tax treaty, this exception applies to payments taken into account in determining net taxable income under the treaty.⁴⁰

The Proposed Regulations do not provide a similar exception for amounts includible as subpart F income or GILTI at the level of the U.S. shareholder of the related foreign recipient.

Treasury Explanation

The preamble states that Treasury and the IRS have determined that a payment to a foreign person should not be taxed as a base erosion payment to the extent that payments to the foreign related party are ECI.⁴¹ The preamble explains that “those amounts are subject to tax under sections 871(b) and 882(a) on a net basis in substantially the same manner as amounts paid to a United States citizen or resident or a domestic corporation.”⁴² The preamble is silent on GILTI and subpart F inclusions.

ACT Recommendation

ACT recommends that an amount paid or accrued to a CFC be excluded from the definition of base erosion payments if such amount:

Similarly, ACT recommends that an amount paid or accrued to a passive foreign investment company (“PFIC”) (within the meaning of section 1296) that is not a CFC be excluded from the definition of base erosion payments to the extent that:

This recommendation also applies to PFICs that are CFCs where the U.S. person making the QEF election does not qualify for the CFC/PFIC overlap rule of section 1297(d).

Reasons for ACT Recommendation

ACT welcomes the exception provided by the Proposed Regulations for payments included by the payee as ECI. In our view, the same policy rationale for an ECI exception applies equally to subpart F income, GILTI, and PFIC income subject to a QEF inclusion. Section 59A is intended to prevent the erosion of the U.S. tax base through deductible outbound payments. Consistent with this objective, payments currently includible in the U.S. tax base should not be treated as base erosion payments. If ACT's recommendation is not adopted, double U.S. corporate taxation will arise, which is inconsistent with Congressional intent.

We recognize that subpart F, GILTI, and QEF inclusions differ from ECI in that they are recognized at the domestic shareholder, rather than the foreign recipient, level by reference to the shareholder's pro rata share. We do not believe, however, that this technical distinction should be a basis for differential treatment, as all of these categories of inclusions in gross income currently produce taxable income to a U.S. tax resident and therefore, do not present base erosion concerns.

The ECI exception is not dependent upon the full amount of the payment being taxed in the United States. ECI, like subpart F income, and tested income, begins with gross income and is thereafter reduced by deductions which can result in the taxable inclusion being less than the deduction.⁴³

Existing regulations under other Code provisions provide ample precedent and an established mechanism for a subpart F/GILTI/QEF income exception that can be readily adapted for section 59A. For example, under the now withdrawn 1991 proposed section 163(j) regulations, interest paid to a CFC that results in an inclusion in the income of a U.S. shareholder under section 951(a)(1) is generally treated as not subject to the interest expense limitation under section 163(j).⁴⁴ A similar rule applies for interest paid to a PFIC which a U.S. person has elected to treat as a QEF to the extent such interest results in an income inclusion to such U.S. person under section 1293(a)(1)(A).⁴⁵

In the subpart F and GILTI context, a deduction for an item payable to a related CFC is triggered under section 267(a)(3)(B) when an amount attributable to that item is includible in the gross income of a U.S. shareholder. Section 163(e)(3)(B)(i) provides a similar rule for original issue discount on a debt instrument held by a related CFC. The proposed regulations under section 951A expand the two rules just discussed to include an item taken into account in determining the net CFC tested income of a U.S. shareholder.⁴⁶

A subpart F/GILTI exception can also be found under the recently issued proposed section 267A regulations. Pursuant to Prop. Reg. § 1.267A-3(b), payments made to (1) a tax resident of the United States (e.g., a foreign corporation with ECI), (2) a CFC with subpart F income that is includible under section 951(a)(1) in the income of a U.S. shareholder (determined without regard to properly allocable deductions of the CFC and qualified deficits under section 952(c)(1)(B)), or (3) a CFC that increases a U.S. shareholder's pro rata share of the tested income (or reduces the shareholder's pro rata share of tested loss) of the CFC under section 951A are not subject to the disallowance of deduction under section 267A.

ACT recommends that a base erosion payment exception similar to all of those listed above be provided when an amount that would otherwise be a base erosion payment triggers a subpart F, GILTI, or QEF inclusion. There is no principled basis for treating section 59A differently from sections 163(j), 267(a)(3)(B), 163(e)(3)(B)(i), and 267A in this regard.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

2. Nonrecognition transactions (Prop. Reg. § 1.59A-3(b)(2)(i))

Proposed Regulation

Prop. Reg. § 1.59A-3(b)(2)(i) provides that an amount paid or accrued includes an amount paid or accrued using any form of consideration, including cash, property, stock, or the assumption of a liability.

As discussed in the preamble, the Proposed Regulations do not provide any exceptions for non-cash consideration (e.g., stock) transferred to a foreign related party that otherwise meets the definition of a base erosion payment in a non-recognition transaction.⁴⁷ Examples of these transactions include a domestic corporation's acquisition of depreciable or amortizable assets from a foreign related party in: (1) a section 351 exchange; (2) a section 332 liquidation; and (3) a section 368 reorganization.⁴⁸

The preamble, however, indicates that a distribution of depreciable property by a foreign related party to a U.S. corporation under section 301 does not give rise to a base erosion payment because there is no consideration provided by the U.S. corporation to the foreign related party in exchange for the property, and, thus, there is no payment or accrual.⁴⁹

Treasury Explanation

The preamble states:

“[Treasury] and the IRS have determined that neither the nonrecognition of gain or loss to the transferor nor the absence of a step-up in basis to the transferee establishes a basis to create a separate exclusion from the definition of a base erosion payment.”⁵⁰

The preamble acknowledges that the importation of depreciable or amortizable assets into the United States in these nonrecognition transactions may increase the regular income tax base.⁵¹ Nevertheless, the preamble states that the statutory definition of a base erosion payment resulting from the acquisition of depreciable or amortizable assets is based on the amount of imported basis in the asset, and an amount of basis is imported in both recognition and nonrecognition transactions.⁵² Treasury and the IRS requested comments on the treatment of payments or accruals that consist of non-cash consideration.⁵³

ACT Recommendation

ACT recommends that in the case of a section 351 exchange, a section 332 liquidation, and a section 368 reorganization where the acquiring company receives depreciable or amortizable property, no amount be treated as a base erosion payment.

Reasons for ACT Recommendation

The nonrecognition provisions (e.g., sections 332, 351, and 368) reflect the legislative judgment that certain corporate transactions such as the formation and dissolution of businesses and the readjustment of continuing interests in property do not warrant the imposition of tax.⁵⁴ Taxing these business transactions under section 59A is contrary to this long-standing judgment of Congress. The legislative history of section 59A evinces no intent that these nonrecognition transactions be taxed under this new provision.

Section 351 is designed to remove a tax impediment to incorporating unincorporated businesses, i.e., a mere change in the form of doing business. The tax free treatment of section 351 transactions represents Congress's intent that the taxation of any built-in gain in the property exchanged for stock should be deferred until a future time, such as when the stock or property received is eventually disposed of.⁵⁵ This treatment of section 351 exchanges is noteworthy in light of the fact that the requirements for qualifying for section 351 treatment are generally less stringent than for certain other nonrecognition provisions.

In the context of tax-free reorganizations, the business purpose requirement embodied in Treas. Reg. § 1.368-1 generally ensures that these transactions are supported by business exigencies and therefore are not abusive.⁵⁶ The business purpose requirement requires that all reorganizations under section 368(a) be undertaken for reasons germane to the continuance of the business in modified corporate form.⁵⁷

Treating inbound section 332 liquidations as giving rise to an amount paid or accrued by the distributee is inappropriate given that the liquidating foreign corporation ceases to exist as a result of the liquidation. In an inbound section 332 liquidation, the foreign subsidiary distributes all of its property to its U.S. parent(s) in complete cancellation or redemption of all its stock.⁵⁸ Assuming, contrary to our view, that stock transfers can be “paid or accrued,” the holding of its own stock by the liquidating corporation is transitory in light of the stock's immediate cancellation, and therefore its transfer should be ignored, as is the case with transitory holdings nearly always in the tax law.⁵⁹ Further, the U.S. parent does not transfer any cash or other property consideration to the liquidating subsidiary. Moreover, it is difficult to reconcile the proposed treatment of liquidating distributions as giving rise to base erosion payments with the treatment of non-liquidating distributions under section 301 as not creating base erosion payments.

We continue to believe that the importation of entire businesses into the United States or change in the form of preexisting U.S. trades or businesses doing business in foreign corporate forms does not give rise to base erosion payments. Inbound business transfers bring taxable income back to the United States — more taxable income generally than isolated acquisitions of depreciable or amortizable property. It is the elimination of such taxable income via deductions, etc., that is section 59A's purpose, not the creation of such taxable income. Subjecting to section 59A business importations will discourage companies from relocating foreign businesses in the United States. A central objective of the TCJA is to bring foreign businesses back to the United States (see, for example, section 250 as applied to foreign derived intangible income).

Further, an inbound transfer of assets previously used in a foreign corporation's U.S. trade or business that were already subject to U.S. federal income tax should not give rise to base erosion payments. This is merely a change in the form of a pre-existing U.S. trade or business. It is illogical to subject these assets to BEAT as the depreciation or amortization on these assets was already deductible in computing ECI.

Tax-free stock transfers are not amounts “paid or accrued” and tax-free stock transfers in exchange for assets do not constitute “purchases” under the Code. Pursuant to section 59A(d)(2), the quoted actions must occur for section 59A to apply. The Code and regulations generally do not treat tax-free stock transfers as “paid or accrued” or as “purchases” of property.⁶⁰ Thus, the Proposed Regulations' expansive interpretation of the quoted terms to reach stock transfers is at odds with the Code and existing regulations. The section 59A statute does not alter the Code in this regard. Accordingly, the section 59A statute does not reach such transactions.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

3. Reporting requirement for qualified derivative payments (Prop. Reg. § 1.59A-6(b)(2); Prop. Reg. § 1.6038A-2)

Proposed Regulation

Under Prop. Reg. § 1.59A-6(b)(2), no payment is a “qualified derivative payment” (“QDP”) for any taxable year unless the taxpayer reports the information required under Prop. Reg. § 1.6038A-2(b)(7)(ix) on Form 8991, Tax on Base Erosion Payments of Taxpayers with Substantial Gross Receipts.

Prop. Reg. § 1.6038A-2(b)(7)(ix) will apply to taxable years beginning one year after final regulations are published. Prop. Reg. § 1.6038A-2(g) provides that prior to the issuance of final regulations, taxpayers are treated as satisfying the reporting requirement by reporting the aggregate amount of QDPs on Form 8991.

Treasury Explanation

N/A.

ACT Recommendations

ACT recommends that (i) an unreported payment may qualify as a QDP if the failure to satisfy the information reporting⁶¹ requirement is due to reasonable cause; and (ii) additional time (i.e., a deferred applicability date or a transition period) be provided before any reporting is required by Prop. Reg. §§ 1.6038A-2(b)(7)(ix) and 1.6038A-2(g) in order to allow taxpayers to implement required systems for tracking and reporting of QDPs.

Reasons for ACT Recommendation

Reporting of QDPs is a new requirement.⁶² As QDPs were not previously tracked and reported, systems and processes must be developed to facilitate such tracking and reporting. Developing and implementing such systems is anticipated to be both time consuming and expensive. This issue is particularly acute since many of the taxpayers whose payments may otherwise qualify as QDPs are large banks and financial institutions that make a significant number of such payments each year. Moreover, the failure to properly report QDPs could have a meaningful impact on a taxpayer's BEAT tax liability, since unreported QDP payments could be treated as base erosion payments (if paid to a foreign related party).

Providing a delay in this reporting requirement would likely make the BEAT more administrable for the government and help taxpayers better comply.⁶³ Treasury and the IRS have previously recognized the complexity in developing similar systems and provided a grace period or delayed effective date.⁶⁴ Providing time to comply with reporting under Prop. Reg. §§ 1.6038A-2(b)(7)(ix) and 1.6038A-2(g) will allow development of a comprehensive reporting system that properly reports and accounts for all of a taxpayer's QDPs.

Additionally, after such transition period expires, the regulations should provide a reasonable cause exception that treats unreported QDPs as if they were reported if the taxpayer can show reasonable cause for its failure to identify such payment(s). Such an exception could consider whether a taxpayer used all ordinary business care and prudence to meet the reporting obligation, but was nevertheless unable to do so. We believe that such an exception is warranted given the (potentially) significant number of payments subject to reporting and the implications if any payments are inadvertently unreported (e.g., all such payments are treated as base erosion payments).⁶⁵

Regulatory Authority for Recommendation

Treasury has authority under section 59A(h)(2)(B) to determine “such other information” that must be reported to carry out the provisions of section 59A(h).

In addition, Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A]” and under section 7805(a) to adopt “all needful rules and regulations.”

4. Applicability of section 15 to section 59A (Prop. Reg. § 1.59A-5(c)(3))

Proposed Regulation

Prop. Reg. § 1.59A-5(c)(3) provides:

Section 15 does not apply to any taxable year that includes January 1, 2018. See [Treas. Reg. §] 1.15-1(d). For a taxpayer using a taxable year other than the calendar year, section 15 applies to any taxable year beginning after January 1, 2018.

Treasury Explanation

N/A.

ACT Recommendation

ACT recommends that regulations:

Reasons for ACT Recommendation

Section 15(a) provides for the computation of tax using a blended tax rate “[i]f any rate of tax imposed by this chapter changes, and if the taxable year includes the effective date of the change (unless that date is the first day of the taxable year).”

Section 15(c)(1) provides that if the rate changes for taxable years “beginning after” or “ending after” a certain date, the following day is considered the effective date of the change. Section 15(c)(2) provides that if the rate changes for taxable years “beginning on or after” a certain date, that date is considered the effective date of the change.

Section 59A(b)(1) provides:⁶⁶

Except as provided in [section 59A(b)(2) and (3)], the term “base erosion minimum tax amount” means, with respect to any applicable taxpayer for any taxable year, the excess (if any) of — 

(A) an amount equal to 10 percent (5 percent in the case of taxable years beginning in calendar year 2018) of the modified taxable income of such taxpayer for the taxable year, over

(B) . . . . (Emphasis added.)

Section 59A(b)(2) provides that “in the case of any taxable year beginning after December 31, 2025, [section 59A(b)(1)] shall be applied by substituting '12.5 percent' for '10 percent' in [section 59A(b)(1)(A)] thereof.”

According to section 59A(b)(1), the applicable rate is 5 percent for taxable years beginning in calendar year 2018 and 10 percent for taxable years beginning in calendar year 2019 (but before January 1, 2026). By its terms, section 15(c) does not apply to determine the effective date of the change in rate as section 59A(b)(1) does not provide for a rate change by reference to taxable years “beginning after,” “ending after,” or “beginning on or after.”

Rather, for any calendar or fiscal year taxpayer, it is unambiguous that under the language of section 59A(b)(1) (above), the BEAT rate takes effect on the first day of a taxable year. For example, with respect to a taxpayer's taxable year beginning on June 1, 2018 (i.e., in calendar year 2018), such taxpayer applies 5 percent to its modified taxable income for such taxable year beginning on June 1, 2018. For its taxable year beginning on June 1, 2019, the taxpayer applies 10 percent to its modified taxable income for such taxable year beginning on June 1, 2019. Therefore, each rate takes effect on the first day of the respective taxable year. Accordingly, the exception in section 15(a) (“unless that date is the first day of the taxable year”) should apply so that section 15(a) is not applicable to the rate change from 5 percent to 10 percent under section 59A(b)(1).

The rate change from 10 percent to 12.5 percent “in the case of any taxable year beginning after December 31, 2025,” however, appears to fall under the language of section 15(c)(1) and as a result, January 1, 2026 would be considered the effective date of the change. This effective date will not be the first day of a fiscal taxable year. Accordingly, it appears a reasonable interpretation of the statute to apply section 15 to a taxable year that begins before and ends after January 1, 2026.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

5. Insurance companies

Proposed Regulation

The Proposed Regulations do not provide any specific rules for claims payments by a domestic reinsurance company to a foreign related insurance company, or for claims payments by a domestic insurance company to its foreign related insureds.

The preamble states that in the case of a domestic reinsurance company, claims payments for losses incurred and other payments are deductible and are thus potentially within the scope of the definition of “base erosion payment” under section 59A(d)(1), but may in certain circumstances also be treated as reductions in gross income which are not deductions and not within the scope of the definition of “base erosion payments” under section 59A(d).⁶⁷

Treasury Explanation

The preamble states:⁶⁸

The proposed regulations also do not provide any specific rules for payments by a domestic reinsurance company to a foreign related insurance company. In the case of a domestic reinsurance company, claims payments for losses incurred and other payments are deductible and are thus potentially within the scope of section 59A(d)(1). See sections 803(c)⁶⁹ and 832(c). In the case of an insurance company other than a life insurance company (non-life insurance company) that reinsures foreign risk, certain of these payments may also be treated as reductions in gross income under section 832(b)(3), which are not deductions and also not the type of reductions in gross income described in sections 59A(d)(3). The Treasury Department and the IRS request comments on the appropriate treatment of these items under subchapter L.

Treasury and the IRS acknowledge in the preamble that, to the extent claims payments for losses are not treated as deductions for non-life insurance companies, asymmetrical treatment would result between claims paid by non-life insurance companies and claims paid by life insurance companies, which are treated only as deductions under part I of subchapter L (the rules for life insurance companies).⁷⁰ Treasury and the IRS requested comments on whether life insurance companies and non-life insurance companies that reinsure foreign risk should be treated in the same manner.⁷¹

ACT Recommendation

ACT recommends that if a U.S. insurance company, including a foreign insurance company that is treated as a domestic insurance company by reason of a section 953(d) election, insures or reinsures risks of a foreign affiliate, the claims, benefits, and losses paid (“Claims Payments”) to the foreign affiliate arising out of the insurance or reinsurance contract should not be treated as base erosion payments.

Reasons for ACT Recommendation

U.S. insurance companies that assume risks of foreign affiliates in exchange for premiums increase the U.S. tax base. Insurance and reinsurance premiums received by a U.S. insurer are invested in the United States and increase U.S. employment from the actuarial, underwriting, investment, accounting, and operations jobs that support the reinsurance. If the Claims Payments pursuant to the insurance or reinsurance agreement are treated as base erosion payments, a U.S. company would likely reduce assumptions of foreign risk. This would result in U.S. companies reducing their U.S. business, which is a result contrary to the policy rationale of BEAT.

Treasury and the IRS include in the Proposed Regulations an exception from the definition of a base erosion payment for any exchange loss on a section 988 transaction, stating in the preamble that “these losses do not present the same base erosion concerns as other types of losses that arise in connection with payments to foreign related party.”⁷² Claims Payments by U.S. insurers and reinsurers likewise do not present the same base erosion concerns as other types of base erosion payments; those Claims Payments result from transferring foreign insurance business into the United States and the associated broadening of the U.S. tax base. Accordingly, like the exclusion of exchange loss on a section 988 transaction from the definition of a base erosion payment, it is necessary and appropriate to include an exception to base erosion payments for Claims Payments made by a domestic insurance company to its foreign related party.

The Proposed Regulations also exclude interest paid or accrued on TLAC securities from the definition of base erosion payments. Similar to the Board of Governors of the Federal Reserve regulations which require banks to issue TLAC securities, generally local regulatory requirements in many countries (including the European Union) effectively compel the use of a locally-licensed insurance company and restrict the ability of a U.S. insurer to engage directly with the ultimate foreign insureds. Accordingly, similar to the TLAC exception, an exception for Claims Payments made by a domestic insurance company to a foreign related company in respect of risks insured or reinsured into the United States would likewise be necessary and appropriate to carry out the provisions of BEAT.

As recognized in the preamble, pursuant to section 832(b)(3) and 832(c), respectively, non-life insurance companies may treat Claims Payments as either reductions to gross income or deductions from gross income. For life insurance companies, as noted in the preamble, section 805(a) unambiguously identifies Claims Payments as deductions. Claims Payments generally represent the majority of expense items for an insurance company. As such, the treatment of Claims Payments for purposes of section 59A is a very important factor in determining whether an insurance company is an “applicable taxpayer” potentially subject to base erosion minimum tax liability under section 59A(a).

There appears to be no policy rationale to treat life insurance companies differently than non — life insurance companies for purposes of section 59A. ACT recommends that life and nonlife insurance companies be treated the same way for purposes of section 59A in line with the policy objectives of BEAT, and accordingly recommends that Claims Payments be reflected consistently with the economic realities of such payments in the calculation of the base erosion percentage for purposes of section 59A.

Regulatory Authority for Recommendation

Treasury has authority under section 59A(i) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of [section 59A].” In addition, Treasury has the authority to adopt “all needful rules and regulations” under section 7805(a).

III. CONCLUSION

We understand that a number of details would need to be addressed if Treasury and the IRS accept the recommendations set forth above. ACT member companies and their advisors have identified a number of these detailed drafting issues and have given some thought as to how they might be addressed. ACT representatives would welcome the opportunity to meet with Treasury and the IRS to discuss any of the above recommendations.