BEAT Regs Have Plenty of Room for Changes, Business Group Says

February 19, 2019

CC:PA:LPD:PR (REG-104259-18)
Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on Proposed Treasury Regulations under Section 59A (NPRM REG-104259-18)

Dear Sir/Madam:

The Organization for International Investment (“OFII”) respectfully submits this letter in response to the Notice of Proposed Rulemaking under section 59A (commonly referred to as the “Base Erosion and Anti-Abuse Tax” or “BEAT”)¹ published by the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “IRS” or “Service”) in the Federal Register on December 21, 2018 (the “Proposed BEAT Regulations”).²

OFII is the only organization focused exclusively on supporting the international business community in Washington. Representing the U.S. operations of many of the world's leading international companies, OFII ensures that policymakers at the federal, state and local level understand the critical role that foreign direct investment (“FDI”) plays in America's economy. OFII advocates for fair, non-discriminatory treatment of foreign-based companies and promotes policies that will encourage them to establish U.S. operations, which in turn increase American employment and U.S. economic growth.

OFII members are among the largest international companies with operations in the United States. Most OFII member companies are in the manufacturing sector, in line with overall FDI in the United States. While more than 60 percent of all international companies in the United States have fewer than 1,000 U.S. employees, OFII members each employ on average more than 12,000 Americans. Not only do these companies make the U.S. economy more resilient, it also means nations all over the globe now have a stake in America's economic success.

As of 2017, there was over $4 trillion of cumulative FDI in the United States. This investment supports more than 24 million workers in the United States, including 7.1 million American workers directly employed by U.S. subsidiaries of foreign-based companies. Importantly, compensation for employees of U.S. subsidiaries of foreign-based companies is 26 percent higher than the private sector average. Over the course of more than two decades of promoting inbound investment in the United States, OFII has always supported transparency, compliance with U.S. laws, and a level playing field for U.S. inbound investment.

It is clear that Congress values the economic benefits of FDI. In connection with tax reform, tax writing committee members indicated that, while seeking to address tax base erosion, they did not want policy that harms legitimate business transactions and the FDI involved.³

I. EXECUTIVE SUMMARY

On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJA” or “Act”) was enacted.⁴ The Act made significant changes to the U.S. tax system and added several new provisions, including section 59A of the Code (i.e., the BEAT). The BEAT raises both administrative and interpretative issues. On December 13, 2018, Treasury and the Service issued the Proposed BEAT Regulations to provide much needed guidance on the application of section 59A.

OFII would like to commend Treasury and the Service for their efforts in developing these proposed regulations, which make great progress in resolving many of the uncertainties and issues raised upon the enactment of section 59A. In OFII's view, many aspects of the Proposed BEAT Regulations embody sound tax policy with respect to several issues under the BEAT, and eliminate arbitrary and unintended disincentives to foreign corporations to engage in activities in the United States.

We highlight below several aspects of the Proposed BEAT Regulations that adopt positions which OFII recommended on behalf of its member companies, and which we believe are consistent with the statute and the broad underlying policies of section 59A:

• The services cost method (“SCM”) exception in section 59A(d)(5) applies regardless of whether there is a markup component (i.e., when a markup is paid for an eligible service, only such portion of the payment that exceeds the total cost of services is not eligible for the SCM exception and is a base erosion payment).⁵

• A taxpayer is not required to maintain separate accounts to bifurcate the cost and markup components of a service charge as a condition to apply the SCM exception.⁶ Requiring taxpayers to keep formal accounts as a condition to apply the SCM exception would be an administrative burden and purely formalistic since a taxpayer is required to keep books and records in order to be able to use the SCM under the section 482 regulations.

• The entire business judgment rule under Treas. Reg. § 1.482-9(b)(5) (and not only the requirement that the services do not contribute significantly to fundamental risks of business success or failure) is disregarded for purposes of the SCM exception under section 59A(d)(5).⁷ Accordingly, taxpayers are able to utilize the SCM exception regardless of whether the services constitute a fundamental element of the taxpayer's core business.

• The base erosion percentage is the percentage in the year in which a net operating loss (“NOL”) arose, or vintage year, rather than the year the NOL is utilized.⁸ Using the base erosion percentage in the year the NOL arose aligns the amount of the modified taxable income (“MTI”) addback attributable to an NOL deduction with the base erosion payments that contributed to the creation of the loss.

• Pre-2018 carryforward of disallowed disqualified interest under former section 163(j) (i.e., business interest carried forward from taxable years beginning before January 1, 2018) that arose from a payment to a foreign related party is not treated as a base erosion payment.⁹

• Pre-2018 NOLs (i.e., NOL deductions allowed under section 172 attributable to losses arising in tax years beginning before January 1, 2018) are excluded from the amount that may be added back for purposes of computing MTI.¹⁰ Excluding pre-enactment NOLs from BEAT is consistent with the effective date of the BEAT provision not to apply to base erosion payments (or losses attributable to such payments) that were paid or accrued in tax years beginning before January 1, 2018.

• A deduction described in section 59A(c)(2)(A)(i) (deduction allowed under Chapter 1 for the tax year with respect to any base erosion payment) or section 59A(c)(2)(A)(ii) (deduction allowed under Chapter 1 for the tax year for depreciation or amortization with respect to property acquired with such payment) that is allowed in a tax year beginning after December 31, 2017 is not treated as a base erosion payment if it relates to an amount paid or accrued in a tax year beginning before January 1, 2018 (i.e., a pre-2018 'vintage year').¹¹

• Taxable income can be reduced below zero for current year operating losses.¹² Allowing taxable income to be reduced below zero based on the definition of section 63(a) is consistent with other provisions where taxable income is the starting point for a computation.¹³

• For related U.S. entities with a single tax filer (e.g., a single U.S. consolidated group), the base erosion minimum tax amount (“BEMTA”) is determined at the tax filer level (i.e., at the consolidated group level).¹⁴ A consolidated group has a tax liability under section 26(b) and computes various amounts that are relevant for purposes of section 59A on a consolidated group basis (e.g., NOLs and the section 163(j) limitation (per Notice 2018-28)).

• In calculating the regular tax liability used in computing a taxpayer's BEMTA, such regular tax liability is not reduced by the amount of credits allowed under sections 33 (credits for taxes withheld at source) and 37 (credits for overpayment of taxes).¹⁵

• The definition of MTI is computed based on an “add-back” approach similar to section 163(j) (as opposed to a “recomputation-based” approach).¹⁶ An add-back approach is consistent with the statutory text and would be the most administrable approach for section 59A purposes.

• Amounts paid or accrued to a foreign related party that are subject to U.S. federal income tax on a net basis — e.g., income that is, or is treated as, effectively connected with the conduct of a trade or business in the United States (“ECI”) or profits attributable to a permanent establishment (“PE”) under a U.S. tax treaty — are not treated as base erosion payments.¹⁷ The approach to exclude from the BEAT amounts already subject to U.S. federal income tax is appropriate since the policy concern that led to the enactment of section 59A (i.e., a U.S. corporation eroding its U.S. tax base by making deductible payments that are subject to little or no U.S. federal income tax) simply does not exist.

• An aggregate approach applies to partnerships so that determinations with regard to the BEAT provisions are made at the partner level (e.g., a U.S. corporation that makes a deductible related-party payment to a foreign partnership with only U.S. partners should not be viewed as making a base erosion payment).¹⁸ The adoption of an aggregate approach to a partnership and making determinations at the partner level are appropriate to carry out the purpose of section 59A and prevent taxpayers from using a partnership to circumvent the application of the new provision.

• Any exchange loss from a section 988 transaction (“section 988 loss”) that is an allowable deduction and that results from a payment or accrual by the taxpayer to a foreign related party is excluded from the definition of a base erosion payment.¹⁹

OFII commends Treasury and IRS for these clarifications and believes that the rules of the Proposed BEAT Regulations highlighted above reflect informed policy judgments with a comprehensive understanding of Congressional intent. These policy judgments are firmly grounded in the law and, therefore, should be finalized in the form in which they were proposed.

OFII believes the Proposed BEAT Regulations provide needed guidance on a wide variety of issues such as the ones highlighted above. In addition, OFII takes this opportunity to recommend that other issues be clarified or addressed as part of final regulations. OFII has identified certain issues under the Proposed BEAT Regulations that have significant and immediate impact to its members and with respect to which it respectfully submits the following recommendations. One group of recommendations, the majority, includes modifications to the Proposed BEAT Regulations. Another group of recommendations includes points with respect to which either Congress or Treasury has already indicated agreement in the legislative history or the Preamble, respectively, and for which OFII is asking for the rationale adopted by Congress and Treasury to be added to the regulatory text. A third group includes recommendations that portions of the Proposed BEAT Regulations not be incorporated in final regulations.

OFII recommends the following modifications to the Proposed BEAT Regulations:

OFII recommends the following modifications to the Proposed BEAT Regulations so as to include in the regulatory text provisions with respect to which either Congress or Treasury has already indicated agreement:

OFII recommends that the following provisions of the Proposed BEAT Regulations not be incorporated in final regulations:

OFII provides below a detailed analysis of the recommendations above, which focus on instances in which OFII believes the Proposed BEAT Regulations are unclear or difficult to apply, treat similarly situated taxpayers unequally, could produce double taxation in contravention of existing U.S. treaty obligations and international norms of cross-border taxation endorsed by Treasury, or appear to depart from the language or purpose of section 59A as expressed in the legislative history to the TCJA.

II. MODIFICATIONS TO THE PROPOSED BEAT REGULATIONS

A. Section 15 should not apply to taxable years beginning in calendar year 2018

1. The Proposed BEAT Regulations

Under section 59A(b)(1), the BEMTA is generally the excess, if any, of “an amount equal to 10 percent (5 percent in the case of taxable years beginning in calendar year 2018) of the modified taxable income”²¹ (emphasis added) over an amount equal to the taxpayer's regular tax liability reduced by certain credits under chapter 1 of the Code.

Section 59A(b)(2)(A) then 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)]” (emphasis added).

For purposes of calculating the BEMTA, the Proposed BEAT Regulations provide in Prop. Reg. § 1.59A-5(c)(3) that (i) “[s]ection 15 does not apply to any taxable year that includes January 1, 2018. See §1.15-1(d)” (emphasis added), and (ii) for a taxpayer using a taxable year other than the calendar year (i.e., a fiscal-year taxpayer), “section 15 applies to any taxable year beginning after January 1, 2018” (emphasis added). The Preamble is silent with respect to the application of section 15 to the BEAT.

Section 15 deals with the effect of changes in rates during the tax year. Under section 15(a), if any tax rate imposed by Chapter 1 of Subtitle A changes “and if the taxable year includes the effective date of the change (unless that date is the first day of the taxable year)” (emphasis added), then such taxable year's tax is determined on the basis of the weighted average of the tax liability for the year as computed using the old rate and the tax liability as computed using the new rate.

For purposes of determining the effective date of a change in tax rate, section 15(c) provides that (1) if the rate changes for taxable years “beginning after” or “ending after” a certain date, the following day shall be considered the effective date of the change, and (2) if a rate changes for taxable years “beginning on or after” a certain date, that date shall be considered the effective date of the change.

By providing that “section 15 applies to any taxable year beginning after January 1, 2018,” Prop. Reg. § 1.59A-5(c)(3) could cause a fiscal-year taxpayer to be subject to section 15 (i.e., to a blended rate of tax between 5 and 10 percent) with respect to its taxable year beginning in calendar year 2018. In OFII's view, though, such interpretation not only would violate section 59A(b)(1) and the legislative history under such provision — which clearly apply a 5 percent rate for the entire taxable year beginning in calendar year 2018 — but also contradict section 15(a) itself, which only applies when there is a change in tax rate in the middle of a taxable year.

2. OFII's Recommendation

OFII recommends that Treasury and the IRS modify Prop. Reg. § 1.59A-5(c)(3) so as to provide that section 15 should not apply to taxable years beginning in calendar year 2018.

3. Reasons for OFII's Recommendation

(a) The application of section 15 to taxable years beginning in calendar year 2018 conflicts with the statute and underlying congressional intent

As referenced above, section 59A(b)(1)(A) provides that, in calculating the BEMTA, the 5 percent rate applies “in the case of taxable years beginning in calendar year 2018)”²² (emphasis added). Therefore, the application of the 5 percent rate coincides with the application of the BEAT itself, which also applies to base erosion payments “paid or accrued in taxable years beginning after December 31, 2017.”²³ In explaining the provisions of the BEAT in the Conference Committee Report to Accompany the Act (the “Conference Committee Report”),²⁴ Congress clarified that the “5 percent rate applies for one year for base erosion payments paid or accrued in taxable years beginning after December 31, 2017”²⁵ (emphasis added).

Therefore, under the plain language of section 59A(b)(1)(A) the 5 percent rate applies to the first taxable year of a taxpayer that will be subject to the BEAT rules (i.e., the taxable year beginning in calendar year 2018), and such a reduced rate was meant by Congress to be applied “for one year,” that is, for the entire taxable year beginning in calendar year 2018. The 5 percent rate is a one-year exception to the generally applicable 10 percent rate, which was granted by Congress as a transition period for the first year of application of the BEAT so as to allow taxpayers to adapt to this new tax regime. Thus, a possible interpretation that section 15 could apply to taxable years beginning in calendar year 2018 so as to cause the 5 percent rate not to apply “for one year” would clearly conflict with section 59A(b)(1)(A) as well as the congressional intent behind the enactment of such provision.

It is generally recognized that administrative regulations cannot go beyond the statute they interpret or implement²⁶ such that their sole purpose is to carry into effect the will of Congress.²⁷

Regulations “must be consistent with the statute to which they apply, and when they have been found not to be so, the courts have not hesitated to strike them down.”²⁸

Hence, if interpreted to mean that a fiscal-year taxpayer should be subject to section 15 (i.e., to a blended rate of tax between 5 and 10 percent) with respect to its taxable year beginning in calendar year 2018, Prop. Reg. § 1.59A-5(c)(3) contradicts the intent of Congress to apply the 5 percent rate “for one year” (i.e., the entire taxable year beginning after December 31, 2017).

(b) The 5 percent rate is not a rate change subject to section 15 but instead an exception to the 10 percent default rate

As referenced above, section 15 applies only when there is a change in tax rate in the middle of a taxable year. In OFII's view, the 5 percent rate provided in section 59A(b)(1), unlike the 12.5 percent rate that applies to taxable years beginning after December 31, 2025, is not a change in the default rate of 10 percent. Instead, as mentioned above, the 5 percent rate is a one-year exception to the generally applicable 10 percent rate.

Evidencing the nature of the 5 percent rate as an exception to the default rate of 10 percent and not as giving rise to a rate change, section 59A, as originally proposed by the Senate in its version of the TCJA, did not even provide for such a reduced rate. As designed by the Senate, the BEMTA would be calculated based on a 10 percent rate of the taxpayer's MTI, and such rate would be changed to 12.5 percent for taxable years beginning after December 31, 2025. The 5 percent rate was then included as part of the House and Senate conference committee agreement, which as previously highlighted explained that the “5 percent rate applies for one year for base erosion payments paid or accrued in taxable years beginning after December 31, 2017”²⁹ (emphasis added). Thus, in implementing the one-time temporary 5 percent rate exception, Congress opted to include it in a parenthetical in section 59A(b)(1)(A) providing for the default 10 percent rate, and not in a separate provision similar to what it did in section 59A(b)(2)(A), which clearly reflects a rate change from 10 percent to 12.5 percent with respect to taxable years beginning after December 31, 2025. If Congress had intended for the 5 percent one-year exceptional rate to be treated as a rate change within the meaning of section 15, it would have used in section 59A(b)(1)(A) the same statutory language as that used in section 59A(b)(2) to change the rate from 10 to 12.5 percent.

Accordingly, because (i) section 15 only applies in the case of a change in a tax rate, and (ii) the 5 percent rate provided in section 59A(b)(1)(A) is an exception to the default 10 percent rate rather than a change in rate, a taxpayer should not be subject to section 15 with respect to its taxable year beginning in calendar year 2018, during which the 5 percent rate should apply for the entire taxable year.

(c) Even if the 5 percent rate were viewed as a rate change, section 15 should still not apply to taxable years beginning in calendar year 2018

As referenced above, section 15 applies if any tax rate changes “and if the taxable year includes the effective date of the change (unless that date [i.e., the effective date of the change] is the first day of the taxable year) . . .”³⁰ (emphasis added). Section 15(c) then provides that (1) if the rate changes for taxable years “beginning after” or “ending after” a certain date, the following day shall be considered the effective date of the change, and (2) if a rate changes for taxable years “beginning on or after” a certain date, that date shall be considered the effective date of the change.

Accordingly, one may note that the section 15(c) should not apply to determine the effective date of the percentage rates provided under section 59A(b)(1)(A) since such provision does not provide for a rate change by reference to taxable years “beginning after,” “ending after,” or “beginning on or after” a certain date. Instead, section 59A(b)(1)(A) provides that the 5 percent rate applies “in the case of taxable years beginning in calendar year 2018.” Therefore, the effective date of the 5 percent rate falls on the first day of the taxable year of the taxpayer beginning in calendar year 2018 (e.g., July 1, 2018) and, consequently, the effective date of the 10 percent rate falls on the first day of the taxable year of the taxpayer beginning in calendar year 2019 (e.g., July 1, 2019). Thus, the exception in the parenthetical in section 15(a) (“unless that date is the first day of the taxable year”) should apply here so as to cause section 15 not to apply to the purported rate change from 5 percent to 10 percent under section 59A(b)(1).

On the other hand, the rate change from 10 percent to 12.5 percent “in the case of any taxable year beginning after December 31, 2025” (emphasis added) seems to fall within the language of section 15(c)(1) such that January 1, 2026 (i.e., the following day) would then be considered the effective date of such rate change. This effective date would not be the first day of the taxable year of a fiscal-year taxpayer such that the exception provided in the parenthetical in section 15(a) should not apply. As a result, it seems reasonable to interpret the statute as applying section 15 (i.e., a blended rate between 10 and 12.5 percent) to a taxable year that begins before and ends after January 1, 2026.

Accordingly, Prop. Reg. § 1.59A-5(c)(3) contradicts (i) section 59A and its legislative history, which provide for the application of the 5 percent rate for the first taxable year of a taxpayer that will be subject to the BEAT rules (i.e., the taxable year beginning in calendar year 2018), as well as (ii) section 15(a), which only applies when there is a change in tax rate in the middle of a taxable year, which is not the case of the 5 percent rate (which enters into effect on the first day of the taxpayer's taxable year).

B. Payments that are made to a CFC that are includible by a U.S. shareholder for purposes of section 951(a) or section 951A should not be treated as Base Erosion Payments

1. The Proposed BEAT Regulations

The Proposed BEAT Regulations take into account the U.S. tax treatment of the foreign recipient for purposes of defining base erosion payments. In particular, Prop. Reg. § 1.59A-3(b)(iii) provides for an important exception from the definition of base erosion payments for payments to a foreign related party that are subject to tax as ECI or a similar standard under a U.S. income tax treaty.³¹ 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.”³² The approach taken by Treasury and the Service to exclude amounts already subject to U.S. federal income tax from the BEAT is not only reasonable, but also consistent with the policies underlying section 59A, besides avoiding double taxation on such amounts.

Yet, no similar exception from the definition of a base erosion payment is provided under the Proposed BEAT Regulations for amounts that are includible in gross income by a U.S. shareholder under section 951(a) (i.e., as subpart F income) or section 951A (i.e., as global intangible low-taxed income — “GILTI”), which thus would continue to be treated as base erosion payments under the Proposed BEAT Regulations. The Preamble is silent on amounts that are includible in a U.S. shareholder's gross income as subpart F income or GILTI.

2. OFII's Recommendation

OFII recommends that Prop. Reg. § 1.59A-3(b) be modified so as to provide that payments that are made to a CFC that are includible by a U.S. shareholder for purposes of section 951(a) or section 951A should not be treated as base erosion payments.

3. Reasons for OFII's Recommendation

Payments that are made to a CFC that are includible by a U.S. shareholder for purposes of subpart F income or GILTI should not be treated as base erosion payments since such payments are already subject to U.S. federal income tax at the U.S. shareholder level and do not present the policy concerns that led to the enactment of the BEAT (i.e., the erosion of U.S. tax base by means of deductible payments to related foreign parties).

Furthermore, in computing MTI, a U.S. shareholder that is also treated as an applicable taxpayer would need to take into account its subpart F and GILTI inclusions (that is, part of taxable income) which would increase its BEAT base and create potential for multiple levels of taxation with respect to the income, if deductible payments to a CFC are treated as base erosion payments.

For example, the payor of the deductible payment may be subject to BEAT tax on the deductible payment, the CFC would be subject to tax on the income locally, and the U.S. shareholder of the CFC would be subject to regular U.S. tax liability on the income under either the subpart F or GILTI regimes and also have to include such amounts in computing the U.S. shareholder's BEAT exposure. As a result, if the Proposed BEAT Regulations are finalized as currently proposed, a domestic corporation may be subject to double taxation with respect to a deductible payment it makes to a CFC, which is not the purpose of section 59A. Evidencing that double taxation is undesirable within the scope of the TCJA, Treasury and the Service exercised the regulatory authority granted by Congress to eliminate the burden of double taxation in the recently enacted regulations under section 267A (the “Proposed Anti-Hybrid Regulations”).³³ Under section 267A, an exception applied to exclude from the definition of disqualified related-party amounts certain related-party interest and royalty payments to the extent such payments would be taken into account as subpart F income by a U.S. shareholder.³⁴ The statute, though, does not state whether section 267A applies to a payment that is included directly in the U.S. tax base (for example, because the payment is made directly to a U.S. taxpayer or a U.S. taxable branch), or a payment made to a CFC that is taken into account under GILTI by such CFC's U.S. shareholders. However, on December 20, 2018, Treasury and the Service issued the Proposed Anti-Hybrid Regulations and expressly provided, with the specific goal of avoiding double taxation, that not only amounts included as subpart F income but also (i) payments taken into account in the gross income of a U.S. tax resident or U.S. taxable branch,³⁵ and (ii) payments included in tested income for purposes of section 951A³⁶ should not be subject to disallowance under section 267A.³⁷

The same concern Treasury and the IRS had when they issued the Proposed Anti-Hybrid Regulations under section 267A (that is, the risk of a domestic company being taxed twice in the United States) is also present in the context of section 59A. Such double taxation will persist should the Proposed BEAT Regulations not be properly amended.

Thus, OFII recommends that Prop. Reg. § 1.59A-3(b) be modified so as to provide that payments that are made to a CFC that are includible by a U.S. shareholder for purposes of section 951(a) or section 951A should not be treated as base erosion payments. This recommendation is consistent with the policy underlying the BEAT as it would mitigate the harsh impact of section 59A for applicable taxpayers that are not otherwise eroding the U.S. tax base with regard to payments subject to subpart F or GILTI.

C. No amount should be treated as “paid or accrued” by a domestic corporation in exchange for depreciable or amortizable property in the context of a non-recognition transaction

1. The Proposed BEAT Regulations

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.

The Preamble states that non-cash consideration (e.g., stock) transferred by a taxpayer to a foreign related party may be a base erosion payment notwithstanding that it is incurred in a non-recognition transaction.³⁸ The Preamble gives examples of a domestic corporation's acquisition of depreciable assets from a foreign related party in a section 351 exchange, a section 332 liquidation, or a section 368 reorganization.³⁹ On the other hand, the Preamble notes that an in-kind distribution under section 301 does not give rise to a base erosion payment because there is no consideration provided by the taxpayer and, thus, no payment or accrual.

The Preamble also provides that Treasury and the Service understand that “neither the non-recognition 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.”⁴⁰

The Preamble acknowledges that the importation of depreciable or amortizable assets into the United States in these non-recognition transactions may increase the regular income tax base as compared to the non-importation of those assets.⁴¹ However, the Preamble notes 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 regardless of whether the transaction is a recognition or non-recognition transaction under the Code.⁴² The Preamble finally states that Treasury and the Service welcome comments on the treatment of payments or accruals that consist of non-cash consideration.⁴³

2. OFII's Recommendation

OFII recommends that Prop. Reg. § 1.59A-3(b)(2)(i) be modified to provide that in the case of a non-recognition transaction described in section 351, a liquidation described in section 332, and a reorganization described in section 368, where the domestic corporation receives depreciable or amortizable property, no amount should be treated as a base erosion payment. Alternatively, OFII recommends that in the case of the non-recognition transactions described above where a domestic corporation receives depreciable or amortizable property with a carryover basis from the transferor that has not been increased in the acquisition, no amount should be treated as a base erosion payment.

3. Reasons for OFII's Recommendation

Congress enacted certain non-recognition provisions (such as sections 332, 351, and 368) based on the theory that certain corporate transactions undertaken with a bona fide business purpose — including the incorporation or termination of businesses, or the continuation of proprietary interests under a modified corporate form — should be accorded tax-free treatment. Accordingly, causing these tax-free transactions to be subject to the BEAT is a surprising result that is not in accordance with a long-standing policy against taxing such transactions.

The early legislative history of section 351, for example, indicates that Congress regarded incorporation exchanges as merely changes in form and that congressional intent in enacting the predecessor of section 351 was to eliminate the impediments to business readjustments by making the incorporation tax-free.⁴⁴ Accordingly, the congressional intent of section 351(a) is to facilitate necessary business readjustments by giving them a favorable tax treatment, and such intent would be frustrated if an inbound contribution of assets were subject to tax under section 59A merely because the transaction involves the importation of depreciable or amortizable assets.

With regard to a section 332 liquidation in which a foreign subsidiary distributes all of its property in liquidation to its U.S. shareholder in complete cancellation or redemption of all its stock, the U.S. shareholder does not transfer any cash or non-cash consideration to the liquidating foreign subsidiary.⁴⁵ The cancellation or redemption of the liquidating foreign subsidiary's stock should not be treated as giving rise to a transfer of such stock by the U.S. shareholder to its subsidiary because such foreign corporation ceases to exist as a result of the transaction. Further, assets acquired in a section 332 liquidation would have already been subject to U.S. tax under either the subpart F income or GILTI regime. Acquisition of assets already subject to U.S. tax presents less of an opportunity for potential base erosion than the acquisition of assets that were not previously subject to U.S. tax. Accordingly, OFII believes that regarding a section 332 liquidation as giving rise to an amount “paid or accrued” by a U.S. corporate shareholder is inappropriate.

In the context of reorganizations, the purpose of section 368 was well stated in King Enterprises, Inc. v. United States as follows: “[c]ongressional policy [as reflected in section 368] is to free from tax consequences those corporate reorganizations involving a continuity of business enterprise under modified corporate form and a continuity of interest on the part of the owners before and after, where there is no basic change in relationships and not a sufficient 'cashing in' of proprietary interests to justify contemporaneous taxation”⁴⁶ (emphasis added). A business purpose requirement provided under Treas. Reg. § 1.368-1 generally ensures that these transactions are supported by business exigencies and, therefore, are not abusive.⁴⁷ Thus, OFII believes that the tax-free treatment of section 368 reorganizations, as intended by Congress, should be respected by section 59A (assuming that all the statutory requirements are met). In these non-recognition transactions, the importation of depreciable property into the United States generally will enhance, rather than erode, the regular income tax base. Hence, notwithstanding Treasury and the IRS's statements in the Preamble, OFII believes that transfers of depreciable or amortizable property in non-recognition transactions into the United States generally involve the on-shoring of income-producing assets, which is a clear policy objective of the Act. Thus, these transactions should not give rise to policy concerns and, therefore, justify an exclusion from the definition of base erosion payments. Subjecting these non-recognition transactions to the BEAT would inevitably discourage companies from relocating income-producing assets into the United States.

OFII understands that it is not the overall purpose of the BEAT to capture transactions in which there is a net increase in the overall value of the U.S. corporation and in the size of its asset base that is subject to U.S. federal income tax. In the case of non-recognition transactions where only stock is used as consideration, the net value of the U.S. acquiring corporation is increased. Such types of transactions should be encouraged by Congress and the Treasury, and this distinction has been drawn in similar contexts.⁴⁸

Treasury has also exercised its authority in other cases to exempt from the definition of base erosion payment amounts that it believes do not present the same base erosion concerns as other types of deductions that arise in connection with payments to a foreign related party. For example, in Prop. Reg. § 1.59A-3(b)(3)(iv), Treasury created an exemption from the definition of base erosion payment for exchange losses from section 988 transactions described in Treas. Reg. §1.988-1(a)(1). In the Preamble, Treasury states its reason for such an exemption: “[t]he Treasury Department and the IRS have determined that these 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.”⁴⁹ It is clear that the amortization of a carryover tax basis of an asset acquired by a U.S. taxpayer from a related party in a non-recognition transaction would not create the same base erosion concerns as other types of deductions and that Treasury should likewise exempt such amounts from the rules of section 59A.

Although the statute does not limit the notion of a payment only to cash payments or accruals for future cash payments and could include non-cash payments, OFII believes that proposed application of the rules to non-cash non-recognition transactions (such as those described in sections 332, 351 and 368) would still be in contravention of the plain meaning of section 59A. Section 59A(d)(1) provides that “[t]he term 'base erosion payment' means an 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” (emphasis added). Clearly, for a payment to be considered a base erosion payment, the deduction must be taken with respect to the payment itself and not with respect to the property acquired. This is why the drafters needed to include section 59A(d)(2) in the Code to deal with purchased property subject to depreciation and amortization. In a non-cash non-recognition transaction, no deduction is ever taken with respect to the transfer of property by the acquirer but only with respect to the property received and clearly section 59A(d)(1) would not apply.

Furthermore, section 59A(d)(2) would also not apply in the case of a non-cash non-recognition transaction. Although section 59A(d)(2) provides that such term includes “any amount paid or accrued . . . in connection with the acquisition . . . of property . . .” (emphasis added), it is important to note that the title of such subparagraph is worded as follows: “PURCHASE OF DEPRECIABLE PROPERTY” (emphasis added). Section 355(d)(5)(A) defines “purchase” as any acquisition, but only if (i) the basis of the property acquired in the hands of the acquirer is not determined by reference to the basis of the property in the hands of the transferor (or under section 1014(a)), and (ii) the property is not acquired in an exchange to which section 351, 354, 355, or 356 applies.⁵⁰ Such definition of the term “purchase” is consistent with the one provided under several other provisions of the Code, which in order to treat a transaction as a “purchase” generally require such transaction not to be one of the nonrecognition transfers described in the Code and that the basis of any property transferred to be determined under section 1012.⁵¹ The Supreme Court has held that a “normal rule of statutory interpretation is that identical words used in different parts of the same statute are generally presumed to have the same meaning.”⁵²

Therefore, the use of the terms “acquisition” in the body of section 59A(d)(2) and “purchase” in the heading of such subparagraph creates, at a minimum, ambiguity as to which concept Congress intended to apply and, in this case, the legislative history should be given deference for purposes of resolving such ambiguity. As expressed by the Supreme Court, if the plain meaning of a statute cannot readily be ascertained from its language, the intention of the lawmakers making the statute or regulation is paramount.⁵³ That is, if Congress has not directly addressed an issue and a court, employing traditional tools of statutory construction, ascertains that Congress had an intention with respect to the issue, that intention is the law and must be given effect.⁵⁴ In this respect, the Conference Committee Report to the Act, in explaining the definition of “base erosion tax benefits,” provides that such term means “in the case of a base erosion payment with respect to the purchase of property of a character subject to the allowance for depreciation (or amortization in lieu of depreciation) . . .” (emphasis added).⁵⁵ Accordingly, and as indicated in the heading of section 59A(d)(2) and the legislative history of the provision, Congress intended that such provision apply to a purchase — a type of acquisition — of depreciable or amortizable property, that is, to a taxable transaction (in which case there is no carryover basis). Therefore, because in the case of non-cash non-recognition transactions no purchase is made (i.e., property is received via a capital contribution, liquidation distribution or a business combination, none of which would be considered a purchase within the plain meaning of the term or relevant tax principles), section 59A(d)(2) should not apply to such transactions, which therefore should not be subject to the BEAT.

In non-recognition transactions, the domestic corporation generally takes a carryover tax basis in the depreciable property. In a section 332 liquidation, the corporate transferee generally takes a basis in the property acquired equal to the basis in the hands of the liquidating corporation. A transferee in a section 368 reorganization or a section 351 transaction will also generally have basis in the property acquired equal to the basis in the hands of the transferor under section 362. Section 334(b)(1)(B) and section 362(e) further ensure that assets with high basis are not inappropriately imported into the United States by reducing the basis of certain built-in loss assets. However, an acquirer of an asset in a partial non-recognition transaction may have higher basis in an asset than the transferor had in certain scenarios.⁵⁶ If Treasury is concerned about non recognition transactions where the basis of the assets acquired is increased in the acquisition, OFII recommends in the alternative that in the case of non-recognition transactions where a domestic corporation receives depreciable or amortizable property with a carryover basis from the transferor that has not been increased in the acquisition, no amount should be treated as a base erosion payment.⁵⁷

D. A loss recognized by the taxpayer on the sale of property to a foreign related party should not be treated as a base erosion payment

1. The Proposed BEAT Regulations

Prop. Reg. § 1.59A-3(b)(1) defines a base erosion payment as a payment or accrual by the taxpayer to a foreign related party that is described in one of four categories, including “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.”⁵⁸ Prop. Reg. § 1.59A-3(b)(2)(i) then 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.

In discussing the concept of “payments or accruals that consist of non-cash consideration,” the Preamble provides that because section 59A(d) defines one of the categories of base erosion payment as a payment or accrual by the taxpayer to a foreign related party with respect to which a deduction is allowable, “a base erosion payment also includes a payment to a foreign related party resulting in a recognized loss; for example, a loss recognized on the transfer of property to a foreign related party”⁵⁹ (emphasis added). Treasury and the IRS then requested comments about the treatment of payments or accruals that consist of non-cash consideration.

2. OFII's Recommendation

OFII recommends that Prop. Reg. § 1.59A-3(b) be modified so as to clarify that a loss recognized by the taxpayer on the sale of property to a foreign related party should not be treated as a base erosion payment.

3. Reasons for OFII's Recommendation

The reference in the Preamble to “a loss recognized on the transfer of property to a foreign related party” as a possible base erosion payment could imply that a loss recognized by the taxpayer upon a transfer such as a sale of property to a foreign related party could give rise to a base erosion payment, which is clearly not a result intended by Congress under section 59A.

Section 59A(d)(1) provides that a base erosion payment is generally any amount paid or accrued by the taxpayer to a related foreign person and with respect to which a deduction is allowable. In the case of a sale of an asset, though, no tax deduction is allowed either for the purchase price or for the value of the asset transferred. The sale may generate corollary tax consequences, such as buyer's amortization or depreciation of the acquired asset or seller's gain or loss from the sale, but neither the purchase price paid by buyer nor the value of the asset transferred by seller itself generates a tax deduction to either buyer or seller. It is for this reason that Congress specifically addressed a U.S. taxpayer's purchase of an asset as potentially giving rise to a base erosion payment in section 59A(d)(2).

With section 59A(d)(2), Congress legislated that, in addition to payments that are immediately tax-deductible, a base erosion payment also includes a U.S. taxpayer's payment for the purchase of an amortizable or depreciable asset. On the other hand, Congress did not prescribe that a U.S. taxpayer's transfer of an asset to a foreign related party pursuant to a sale of that asset to the foreign related party would be considered a base erosion payment. As such, there is no statutory authority in section 59A to treat the sale of an asset, which does not give rise to a deduction in the United States, as a base erosion payment.

Section 59A(c)(2) provides, in relevant part, that base erosion tax benefit includes: (i) any deduction with respect to any base erosion payment described in section 59A(d)(1), and (ii) any deduction for depreciation or amortization with respect to the purchase of an asset as described in section 59A(d)(2). In the case of a U.S. taxpayer's sale of an asset to a related foreign party, such transfer does not give rise to any tax deduction. Even if the U.S. taxpayer recognizes a loss as a result of the sale, such loss is not a deduction with respect to a base erosion payment. Congress would have had to draft specific statutory language if it had intended to treat such a loss as a base erosion tax benefit. Thus, there is no statutory authority in section 59A to treat any loss realized by the U.S. seller on the sale of an amortizable or depreciable property as a base erosion tax benefit.

Reinforcing the inapplicability of section 59A when the U.S. taxpayer is the seller, and not the purchaser, of an asset, any potential for base erosion in such a circumstance has already (and specifically) been considered by Congress when it enacted section 267, such that there would be no need for Congress to create a further backstop. Under section 267, any loss from the sale of property to a more than 50 percent related foreign entity is either denied⁶⁰ or, in the case of transactions between members of a controlled group of corporations, deferred until the property is later transferred to a person outside the group.⁶¹ Therefore, section 267 precisely addresses the concern that taxpayers could try to erode the U.S. tax base by claiming losses on the sale of property that remains in the hands of a person who bears a close relationship to the taxpayer.

Accordingly, for the reasons described above, OFII recommends that Prop. Reg. § 1.59A-3(b) be modified so as to clarify that a loss recognized by the taxpayer on the sale of property to a foreign related party should not be treated as a base erosion payment.

E. QDP reporting requirements

1. The Proposed BEAT Regulations

The Proposed BEAT Regulations provide new information reporting requirements. Under Prop. Reg. § 1.59A-6(b)(2), no payment is a QDP for any taxable year unless the taxpayer reports the information required under Prop. Reg. § 1.6038A-2(b)(7)(ix).

Prior to the effective date of final regulations, Prop. Reg. § 1.6038A-2(g) provides that taxpayers satisfy the reporting requirements for QDPs as provided under Prop. Reg. § 1.59A-6(b)(2) by reporting the aggregate amount of QDPs for the taxable year on Form 8991, Tax on Base Erosion Payments of Taxpayers with Substantial Gross Receipts.⁶² Such “simplified” QDP reporting requirement is proposed to apply to taxable years beginning after December 31, 2017.

2. OFII's Recommendations

OFII recommends that final regulations include a reasonable cause exception for a failure to comply with the reporting requirements provided under Prop. Reg. § 1.6038A-2(b)(7)(ix) and Prop. Reg. § 1.6038A-2(g).

OFII also recommends that Prop. Reg. § 1.6038A-2(g) be modified so as to provide additional time (i.e., a transition period) before any QDP reporting requirement is imposed as a condition for taxpayers to benefit from the QDP exception of Prop. Reg. § 1.59A-3(b)(3)(ii).

3. Reasons for OFII's Recommendations

(a) The QDP reporting requirements should include a reasonable cause exception for a failure to comply

As currently proposed, the Proposed BEAT Regulations do not include a reasonable cause exception with respect to the QDP reporting requirements.

However, the BEAT rules, including those applicable to the QDP exception and its reporting requirements, are new and unfamiliar to all taxpayers. Before the Proposed BEAT Regulations, there was no need for taxpayers to track and report QDPs, so new systems and processes must be developed to facilitate such tracking and reporting. Thus, it would be unfair to penalize a taxpayer without any exception for an error made despite the taxpayer's exercise of ordinary business care and prudence. Given the fact that certain taxpayers such as banks and other financial institutions deal with millions of QDPs every year and such payments are not currently segregated into separate accounts or otherwise separately “tagged” on the taxpayers' books and records, taxpayers will face challenges in reporting with total accuracy the information required to be submitted to the IRS, especially in the first few years that the BEAT is in place. Since a failure to report a QDP will cause each unreported QDP to be considered a base erosion payment (if paid to a foreign related party),⁶³ the consequences of such an inadvertent reporting failure will be severe.

Therefore, OFII strongly believes that taxpayers should not be penalized where they have acted in good faith and there is reasonable cause for failing to track and report QDPs. Accordingly, OFII recommends that final regulations include a reasonable cause exception for a failure to comply with the reporting requirements provided under Prop. Reg. § 1.6038A-2(b)(7)(ix) and Prop. Reg. § 1.6038A-2(g).⁶⁴

(b) Additional time (i.e., a transition period) should be provided before any QDP reporting requirement is imposed as a condition for the QDP exception to apply

Prop. Reg. § 1.6038A-2(g) provides some welcome relief by not requiring the fulfillment of the reporting requirements provided under Prop. Reg. § 1.6038A-2(b)(7)(ix) until the Proposed BEAT Regulations become final.

However, companies and their advisors still need time to absorb and understand the Proposed BEAT Regulations, including the QDP exception rules. Moreover, because certain taxpayers such as banks and other financial institutions deal with a significant number of QDPs every year and such payments are not currently segregated into separate accounts or otherwise separately “tagged” on the taxpayers' books and records, taxpayers will likely have to consider implementing system changes, new policy manuals, and updates to internal control procedures before being able to implement any required systems for tracking and reporting QDPs. This process will be time consuming, and it would be unreasonable to require taxpayers to be able to track and report QDPs for the first few years in which section 59A is effective as a condition for such taxpayers to avail themselves of the QDP exception. Taxpayers need time to prepare to comply with these new rules. Recognizing the complexity involved in the development of new reporting systems, in other instances Treasury and the Service have provided a grace period for new reporting obligations to become enforceable.⁶⁵

Therefore, OFII recommends that Prop. Reg. § 1.6038A-2(g) be modified so as to provide additional time (i.e., a transition period) before any QDP reporting requirement is imposed as a condition for taxpayers to benefit from the QDP exception of Prop. Reg. § 1.59A-3(b)(3)(ii).

F. Claims and benefits payments and accruals by a domestic insurance company to a foreign related reinsurance company should not be treated as base erosion payments

1. The Proposed BEAT Regulations

Treasury and the IRS requested comments on the treatment of payments by a domestic reinsurance company to a foreign related insurance company. Specifically, comments were requested as to whether for a non-life insurance company such payments should be treated as a reduction of gross income under section 832(b)(3) or as a deduction under section 832(c). In addition, Treasury and the Service noted the potential difference in the treatment of such payments for life insurance companies and requested comments whether life and non-life companies should be treated the same.

2. OFII's Recommendation

OFII recommends that both life and nonlife insurance companies be treated the same way for purposes of the BEAT, and in line with the policy objectives of the BEAT. Accordingly, OFII recommends that Prop. Reg. § 1.59A-3(b) be modified so as to provide that the claims, benefits, and losses paid or accrued (i.e., Claims Payments) made to foreign affiliates arising from reinsurance provided to them by a U.S. life or non-life insurance company should not be treated as base erosion payments. Further, all Claims Payments (and losses and expenses incurred for non-life insurance companies) be treated as deductions for both life and non-life insurance companies for purposes of the denominator when computing the base erosion percentage.

3. Reasons for OFII's Recommendation

U.S. insurance companies that assume risks of foreign affiliates in exchange for premiums increase the U.S. tax base. Reinsurance premiums received by the U.S. reinsurer are invested in the United States and increase U.S. employment from the actuarial, underwriting, investment, accounting, and operation jobs that support the reinsurance. Claims Payments pursuant to the reinsurance are an integral part of such reinsurance. If the Claims Payments pursuant to the reinsurance agreement are treated as base erosion payments, the 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 the BEAT. In effect, U.S. reinsurers would be penalized for expanding their U.S. insurance business and increasing the U.S. tax base.

Although such treatment finds support in Subchapter L, it treats life and non-life companies differently and is ambiguous when applicable, as noted in the Preamble. The Preamble provides:

As recognized in the Preamble, pursuant to sections 832(b)(3) and 832(c) respectively, non-life insurance may treat Claims Payments as either deductions from gross income or reductions to gross income. Although the ambiguity in the statute is not new, it has not created any concerns previously as either treatment results in the determination of the same taxable income. (Section 832(d) prevents a double deduction from being claimed.) However, for purposes of section 59A, treating Claims Payments as deductions may lead to treating them as base erosion payments, whereas treating them as reductions in gross income would not. Therefore, taxpayers, interpreting the Subchapter L provisions with an objective to reducing the BEAT, could take inconsistent positions. The ambiguity in the statute also raises the question as to whether, for purposes of computing the base erosion percentage, Claims Payments (and in general losses and expenses incurred) of a non-life insurance company should be included in the denominator or not. The uncertainty created by this ambiguity may lead to controversies because depending on how the denominator is computed, the base erosion percentage will vary in dramatic ways affecting whether a taxpayer is an applicable taxpayer, and if it is one, the applicable percentage that has to be applied to NOLs for the MTI determination.

For life insurance companies, section 805(a)(1) identifies Claims Payments as deductions. Therefore, whereas non-life insurance companies may be able to exercise a choice and suffer uncertainty as to the treatment of Claims Payments for purposes of the denominator, life insurance companies would neither have the choice nor the uncertainty. However, there appears to be no policy rationale to treat life insurance companies differently than non-life insurance companies for purposes of section 59A. Even within life insurance company tax rules, ambiguity arises if the life insurance company issues non-life policies as the rules related to such non-life Claims Payments are less clear.

G. Taxpayers should be allowed to elect to compute their MTI and BEMTA on an aggregated group basis

1. The Proposed BEAT Regulations

The Preamble clarifies that the computations of MTI and BEMTA are done on a taxpayer-by-taxpayer basis (treating a consolidated group as a single taxpayer) rather than using an “aggregate group” concept.⁶⁸ The latter concept, thus, would only apply for the purpose of determining whether a taxpayer is an applicable taxpayer and the base erosion percentage of any NOL deduction.⁶⁹

According to Treasury and the Service, “in the absence of these clarifying definitions, taxpayers could calculate the BEMTA differently depending on their differing views of the base on which the BEAT should be calculated (i.e., aggregated group, consolidated group, individual company), leading to inequitable results across otherwise similar taxpayers.”⁷⁰ The Preamble also provides that the approach of calculating the BEAT liability on a separate taxpayer basis is expected to be less costly for taxpayers and would simplify the BEAT calculations.⁷¹

2. OFII's Recommendation

OFII recommends that the Proposed BEAT Regulations be modified so as to allow taxpayers to elect to compute their MTI and BEMTA on an aggregated group basis based on the controlled group definition described in section 59A(e)(3), instead of computing such amounts on a taxpayer-by-taxpayer basis.

3. Reasons for OFII's Recommendation

For the reasons briefly described below, OFII respectfully requests that Treasury and the Service consider the possibility of allowing taxpayers that are members of an aggregate group to elect to compute their BEAT liability (i.e., their MTI and BEMTA) on an aggregated group basis. The recommendation for an election — rather than a mandatory rule — allowing taxpayers to compute the BEAT liability based on an aggregate group basis would reach an impartial result as it would not burden taxpayers that would otherwise choose not to use the aggregate group approach. To make such an election simple to administer, as well as avoid any additional complexity or unforeseen consequences, OFII believes Treasury and the Service could require the observance of certain requirements by the electing members of an aggregate group.⁷²

First, OFII believes that the legislative history under section 59A would arguably authorize the application of the aggregate approach for the computation of the BEAT liability. The flush language under section 59A(e) states that the definition of “applicable taxpayer” applies for all purposes of section 59A, and the aggregation rule itself is an embedded part of the “applicable taxpayer” definition.⁷³ Moreover, although section 59A(e)(3) arguably limits the application of the aggregate approach for purposes of determining whether a taxpayer is an applicable taxpayer and the base erosion percentage, in the Conference Committee Report to the Act Congress expressly provided that “[a]ll persons treated as a single employer under section 52(a) are treated as one person for purposes of this provision [i.e., for all purposes under section 59A] . . .” (emphasis added).⁷⁴ Thus, determining the BEAT liability on an aggregated group basis would not be inconsistent with the legislative intent underlying such statutory provision.

Furthermore, Treasury and the Service expressed, in the Preamble, a concern that the calculation of the BEAT liability at an aggregate group level would lead to inequitable results across otherwise similar taxpayers. However, OFII believes some inequitable results may already occur under the Proposed BEAT Regulations depending on certain circumstances and regardless of the adoption of the aggregate approach for the computation of the BEAT liability.⁷⁵ The computation of the BEAT liability on an aggregate group basis — which more accurately reflects the economics of an aggregate group by treating it as a single economic unit — would actually prevent some of these inequities from happening,⁷⁶ thus also justifying its inclusion, as an election, in final regulations to be issued under section 59A.

Finally, in spite of the concern expressed in the Preamble regarding an alleged increase in complexity resulting from the computation of the BEAT liability on an aggregate group basis, the information that would be necessary to compute the aggregate BEAT liability is already available in existing tax forms and, thus, could be easily obtained and used by taxpayers for purposes of the suggested election with little additional administrative effort or cost.⁷⁷

III. INCLUSIONS TO THE TEXT OF FINAL REGULATIONS

Below are the recommendations that include points with respect to which either Congress or Treasury has already indicated agreement in the legislative history or the Preamble, respectively, and for which OFII is asking for the rationale adopted by Congress and Treasury to be added to the regulatory text.

A. Payments resulting in a reduction in gross income under section 61, including COGS, should not be treated as base erosion payments

1. The Proposed BEAT Regulations

As referenced above, Prop. Reg. § 1.59A-3(b)(1) defines a base erosion payment as a payment or accrual by the taxpayer to a foreign related party that is described in one of four categories, including “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.”⁷⁸

2. OFII's Recommendation

OFII recommends that, when issued in final form, Prop. Reg. § 1.59A-3(b) be modified so as to clarify that any payments resulting in a reduction in gross income under section 61, including COGS, should not be treated as base erosion payments.

3. Reasons for OFII's Recommendation

As referenced above, a base erosion payment generally means any amount paid or accrued by a taxpayer to a foreign person that is a related party of the taxpayer and with respect to which a deduction is allowable under Chapter 1 of the Code.

Therefore, because COGS are reflected as a reduction in gross income rather than a deduction from a taxpayer's income, as noted in the Conference Committee Report to the Act, “base erosion payments do not include . . . payments for cost of goods sold.”⁷⁹ In that respect, the Preamble also distinguishes deductible payments (i.e., payments that are potentially subject to the BEAT) from reductions in gross income (i.e., payments that generally do not qualify as base erosion payments and, thus, are not subject to the BEAT) when it provided that “[i]n general, the treatment of a payment as deductible [i.e., a payment subject to the BEAT], or as other than deductible, such as an amount that reduces gross income or is excluded from gross income [i.e., a payment that generally is not subject to the BEAT] because it is beneficially owned by another person, generally will have federal income tax consequences that will affect the application of section 59A and will also have consequences for other provisions of the Code.”⁸⁰ However, the Proposed BEAT Regulations do not contain a provision that expressly provides that amounts paid or accrued to a related foreign person that result in reductions of gross income (such as COGS) are not treated as base erosion payments.⁸¹ The only express reference to reductions of gross income in the Proposed BEAT Regulations is in the provisions stating that certain specific payments that result in reductions in gross income will be included as base erosion payments (i.e., certain reinsurance payments and amounts paid or accrued to certain inverted companies).⁸²

Although there is no debate that a “reduction in gross income” does not mean the same thing as a “deduction,” OFII believes that in order to avoid any unintended consequences and provide more certainty to taxpayers, final regulations should expressly reflect that payments that result in reductions of gross income (rather than in deductions) are not subject to section 59A.

Accordingly, OFII recommends that, when issued in final form, Prop. Reg. § 1.59A-3(b) be modified so as to clarify that, with the exception of the specific payments provided under sections 59A(d)(3) and 59A(d)(4),⁸³ any payments resulting in a reduction in gross income under section 61, including COGS, should not be treated as base erosion payments.

B. The treatment of a payment as a deductible payment, or as a reduction in gross income under section 61, is to be made under existing law

1. The Proposed BEAT Regulations

The Proposed BEAT Regulations do not establish any specific rules for determining if a payment is treated as deductible for section 59A purposes.

In particular, the Preamble indicates the Proposed BEAT Regulations do not explicitly address the classification of certain payments (e.g., a royalty payment) as either a deductible expense under section 162 (and potentially a base erosion payment) or a cost capitalized in inventory under sections 471 and 263A that would result in a reduction in gross income under section 61 (and generally not considered a base erosion payment).⁸⁴

The Preamble further provides that the determination of whether a payment or accrual by the taxpayer to a foreign related party constitutes a base erosion payment is to be made under general U.S. federal income tax law, including the rules dealing with identifying who is the beneficial owner of income, who owns an asset, and the related tax consequences, such as under principal-agent principles, cost reimbursement doctrine, case law conduit principles, assignment of income, or other generally applicable tax principles.⁸⁵

2. OFII's Recommendation

OFII recommends that, when issued in final form, Prop. Reg. § 1.59A-3(b)(2) be modified so as to include a rule that reads as follows:

“(2) Operating rules.

(vii) Treatment of payments. For purposes of section 59A, the treatment of a payment as a base erosion payment (i.e., as deductible, or as other than deductible, such as a reduction in gross income under section 61) is to be made under existing law dealing with identifying who is the beneficial owner of income, who owns an asset, and the related tax consequences (including under principal-agent principles, cost reimbursement doctrine, case law conduit principles, assignment of income, or other generally applicable tax principles). Additionally, in making this determination all applicable rules relating to classification of property or expenses treated as inventory shall also be made taking into account all existing tax principles including, but not limited to, those contained in sections 263A and 471.”

3. Reasons for OFII's Recommendation

Treasury and the IRS's position that the determination of whether a payment or accrual by the taxpayer to a foreign related party constitutes a base erosion payment is to be made under general U.S. federal income tax law is only contained in the Preamble and has not been reflected in any provision of the Proposed BEAT Regulations.

However, the Code of Federal Regulations, in which final regulations are codified, does not include preambles. In addition, most secondary sources either do not include preambles or, at best, reprint them separately from regulation text. Furthermore, a sentence in a preamble does not have the force of law and is not controlling over the language of the regulation itself.⁸⁶ Hence, the possible absence in final regulations to be issued under section 59A of the language contained in the Preamble may cause confusion among taxpayers and tax practitioners when determining whether a certain payment is to be treated as deductible for BEAT purposes and, thus, as a base erosion payment. In a world of simplified tax regulations, knowledge of significant rules should not require one to look beyond the regulatory language.

Therefore, in order to avoid any ambiguity, and to provide more certainty to taxpayers, OFII recommends that, when issued in final form, Prop. Reg. § 1.59A-3(b)(2) be modified so as to include in the regulatory text the language contained in the Preamble providing that the treatment of a payment as a base erosion payment (i.e., as deductible, or as other than deductible, such as a reduction in gross income under section 61) is to be made under existing law dealing with identifying who is the beneficial owner of income, who owns an asset, and the related tax consequences (including under principal-agent principles, cost reimbursement doctrine, case law conduit principles, assignment of income, or other generally applicable tax principles).

IV. PROVISIONS OF THE PROPOSED BEAT REGULATIONS NOT TO BE INCORPORATED IN FINAL REGULATIONS

A. Internal dealings should be excluded from the definition of a base erosion payment

1. The Proposed BEAT Regulations

Prop. Reg. § 1.59A-3(b)(4)(v)(B) provides that when a foreign corporation determines the profits attributable to a PE by applying transfer pricing principles by analogy (pursuant to an applicable income tax treaty), any deduction attributable to any amount paid or accrued (or treated as paid or accrued) by the PE to the foreign corporation's home office or to another branch of the foreign corporation (i.e., an “internal dealing”) is treated as regarded, and may therefore constitute a base erosion payment.

Even though Treasury and the Service recognized, in the Preamble, that (i) the use of a treaty-based expense allocation or attribution method does not, in and of itself, create legal obligations between the U.S. PE and the rest of the enterprise, and (ii) the deductions from internal dealings would not be allowed under the Code and regulations, they justified the treatment of internal dealings as base erosion payments based on the argument that such an approach “creates 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).”

2. OFII's Recommendation

OFII recommends that Prop. Reg. § 1.59A-3(b)(4)(v)(B) not be incorporated in final regulations such that internal dealings should be excluded from the definition of a base erosion payment.

3. Reasons for OFII's Recommendation

(a) Internal Dealings — Overview

Under both the 2006 and 2016 United States Model Income Tax Treaties, as well as certain other U.S. tax treaties (or protocols),⁸⁷ profits attributable to a PE are those that the PE would be expected to derive if it were a separate and independent enterprise performing the activities that cause it to be a PE, taking into account functions performed, assets used and risks assumed by the PE. Such an approach to attributing profits to a PE is commonly referred to as the Authorized OECD Approach (“AOA”), which recognizes internal transactions for profit attribution purposes (i.e., internal dealings between the U.S. branch and the home office or other branches of a corporation).

However, the AOA hypothesizes the PE as a separate entity solely “to attribute income to a permanent establishment in cases where the dealings accurately reflect the allocation of risk within the enterprise,”⁸⁸ since “[u]nder U.S. domestic regulations, internal 'transactions' generally are not recognized because they do not have legal significance.”⁸⁹ The OECD “2010 Report on the Attribution of Profits to Permanent Establishments” (the “2010 OECD Report”)⁹⁰ for determining the amount of business profit that is taxable to a PE emphasizes the specific and limited application of the AOA, as follows:

“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).⁹¹

Accordingly, under the AOA, internal dealings are regarded only to provide a reference for the attribution of profits and, as such, should not have any relevance in any other context for tax purposes. In that regard, the U.S. Treasury Technical Explanation to several U.S. income tax treaties, including the 2006 U.S. Model Tax Treaty, provides:

“[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.”⁹² (Emphasis added.)

Reinforcing the irrelevance of internal dealing for purposes other than the attribution of profits under a double tax treaty, the 2010 OECD Report provides that “the recognition of investment income on attributed assets is relevant only for the attribution of profits to the PE under Article 7 and does not carry wider implications as regards, for example, withholding taxes.”⁹³ (Emphasis added.)

It should be mentioned that this same treatment of “internal dealings” as transactions that are not recognized for U.S. federal income tax purposes is applied under other provisions of the Code dealing with transactions between branches or a branch and its home office. 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.” Also based on the theory that an entity cannot deal with itself, Treas. Reg. § 1.446-3(c)(1)(i) provides that “[a]n agreement between a taxpayer and a qualified business unit (as defined in section 989(a)) of the taxpayer, or among qualified business units of the same taxpayer, is not a notional principal contract because a taxpayer cannot enter into a contract with itself.”⁹⁴

Accordingly, because under the U.S. income tax treaties internal dealings should not be given any effect for U.S. federal income tax purposes, they should not be treated differently under the BEAT rules so as to contradict the established principle that a “taxpayer cannot enter into a contract with itself.”

(b) No “payment” is made or accrued by the U.S. PE

Under section 59A, the BEAT applies when there is a base erosion payment paid or accrued by the taxpayer to a foreign related party. According to section 59A(d)(1), base erosion payment generally means “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.”

Internal dealings, however, are a mere fiction that hypothesizes a PE as a separate entity for the sole and specific purpose of determining the business profits to be attributed to such PE, and do not involve an actual payment or accrual under general U.S. tax principles. Nothing in section 59A nor in its legislative history indicates that Congress intended that a base erosion payment should also include an amount “deemed” paid or accrued by the taxpayer to a foreign related party in a fictional transaction that exists only for certain purposes of certain tax treaties. Thus, subjecting such fictional transactions to the BEAT is clearly at odds with congressional intent as expressed in specific language in the statute.

Moreover, even if the U.S. PE would make an actual payment to either its home office or another branch, such payment still would not qualify as a base erosion payment, which under section 59A(d)(1) requires a payment by the taxpayer to a “foreign person which is a related party of the taxpayer” — that is, a payment from a person to another person. As a permanent establishment or a branch and its head office are legally the same person, any payments between them have no legal consequences for the enterprise as a whole and, for this reason, are disregarded for U.S. federal income tax purposes. Thus, a payment from a U.S. PE to its head office or another branch would not constitute a payment between two different persons and, as such, should not give rise to a base erosion payment.

Therefore, because (i) for the BEAT to apply, section 59A requires an amount “paid or accrued” by the taxpayer to a related foreign person, and (ii) internal dealings are not actual payments or accruals from one entity to another, such that the deductions from internal dealings would not be allowed under the Code and regulations, the treatment of internal dealings as giving rise to base erosion payments does not have any statutory basis. As referenced above, it is generally recognized that administrative regulations cannot go beyond the statute they interpret or implement⁹⁵ such that they “must be consistent with the statute to which they apply, and when they have been found not to be so, the courts have not hesitated to strike them down.”⁹⁶

Thus, notwithstanding Treasury and the IRS's goal of creating parity between deductions for actual regarded payments and internal dealings, based on the language used by Congress under section 59A (requiring an amount to be paid “paid” or “accrued” by the taxpayer), OFII recommends that internal dealing amounts not be treated as base erosion payments, and they therefore should be excluded from the scope of the BEAT.

(c) Prop. Reg. § 1.59A-3(b)(4)(v)(B) violates U.S. income tax treaties

As discussed above, the AOA treats the PE as a separate entity solely for purposes of determining an appropriate profit attribution.

As explained by Treasury in its Technical Explanation to several U.S. income tax treaties, and recognized by Treasury and the Service themselves in the Preamble, such method of profits attribution “does not create legal obligations or other tax consequences that would result from transactions having independent legal significance.”⁹⁷ Such treatment of the AOA given by Treasury is consistent with how the OECD has designed such method of profits attribution, i.e., as being “relevant only for the attribution of profits to the PE under Article 7 and does not carry wider implications as regards, for example, withholding taxes,”⁹⁸ that is, for tax purposes. Therefore, by treating internal dealings as regarded transactions that may potentially give rise to base erosion payments, Prop. Reg. § 1.59A-3(b)(4)(v)(B) clearly violates the U.S. income tax treaties that have incorporated the AOA as a method of profit attribution under Article 7.

Moreover, under Article 7(1) of the U.S.-U.K. Treaty,⁹⁹ for example, if a foreign resident carries on business in the United States through a PE, the United States may impose tax on any “business profits” that are attributable to the PE. Article 7(3) of the U.S.-U.K. Treaty then provides that the business profits of a PE are determined with deductions for all expenses incurred for the purpose of the PE. In explaining such provision, the Department of Treasury Technical Explanation to the U.S.-U.K. Treaty provides that, under Article 7(3), “deductions shall be allowed for the expenses incurred for the purposes of the permanent establishment, ensuring that business profits will be taxed on a net basis” (emphasis added). Thus, the possible treatment of deductions from internal dealings as base erosion payments would violate Article 7(3) of the U.S.-U.K. Treaty (and other U.S. income tax treaties with a similar provision) to the extent that it could cause a foreign corporation to be taxed in an amount higher than the net business profits attributed to the U.S. PE.

Treaties are not given precedence over statutes because of their nature as treaties.¹⁰⁰ Under the Constitution, treaties rank, with federal laws, as the supreme law of the land.¹⁰¹ Historically, though, absent specific legislative history or explicit statutory override, courts have upheld existing treaties that conflict with subsequent laws.¹⁰² According to the Supreme Court, a “treaty will not be deemed to have been abrogated or modified by a later statute, unless such purpose on the part of Congress has been clearly expressed.”¹⁰³ Therefore, if courts will not interpret a statute to abrogate a treaty without clear congressional intent, then regulations issued under such statute should also not be treated as overriding U.S. income tax treaties.

In enacting section 59A, though, Congress expressed no explicit intent to override U.S. income tax treaties, whether in the statute or in the legislative history.¹⁰⁴ Accordingly, because Prop. Reg. §1.59A-3(b)(4)(v)(B) contradicts U.S. income tax treaties without adequate statutory authority, internal dealings should be excluded from the definition of a base erosion payment.

B. Section 988 losses should be included in the denominator of the base erosion percentage

1. The Proposed BEAT Regulations

Prop. Reg. § 1.59A-3(b)(3)(iv) excludes from the definition of a base erosion payment any section 988 loss that is an allowable deduction and that results from a payment or accrual by the taxpayer to a foreign related party. According to Treasury and the IRS, “these 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.”¹⁰⁵

Further, Prop. Reg. § 1.59A-2(e)(3)(ii)(D) provides that all section 988 losses (from transactions with foreign related parties and persons other than foreign related parties) are excluded from the denominator when computing the taxpayer's base erosion percentage. However, under Prop. Reg. § 1.59A-2(d), all section 988 gains are included as a gross receipt for purposes of the gross receipts test.

Treasury and the IRS specifically requested comments on whether section 988 losses should be excluded from the denominator for purposes of computing the base erosion percentage, including whether such exclusion should be limited to transactions with foreign related parties.

2. OFII's Recommendations

OFII recommends that Prop. Reg. § 1.59A-2(e)(3)(ii)(D) not be incorporated in final regulations such that any exchange losses from a section 988 transaction (i.e., section 988 losses) are included in the denominator of the base erosion percentage. Alternatively, OFII recommends that section 988 losses from transactions with unrelated parties be included in the denominator of the base erosion percentage.

3. Reasons for OFII's Recommendations

The Proposed BEAT Regulations generally provide welcome relief for taxpayers with section 988 losses by not treating such losses as base erosion payments. However, for several taxpayers that regularly enter into section 988 transactions, excluding section 988 losses from the denominator for purposes of computing the base erosion percentage would be an unwelcome result.

Section 988 losses are totally out of the taxpayer's control, being caused solely and exclusively by market fluctuations. Accordingly, it would be unreasonable to exclude section 988 losses from the denominator of the base erosion percentage calculation — thus making it more likely that taxpayers would exceed the base erosion percentage threshold — in situations that do not involve base erosion concerns that section 59A was designed to foreclose.

Therefore, OFII recommends that Prop. Reg. § 1.59A-2(e)(3)(ii)(D) not be incorporated in final regulations such that any exchange losses from a section 988 transaction (i.e., section 988 losses) be included in the denominator of the base erosion percentage.

Alternatively, OFII recommends that section 988 losses from transactions with unrelated parties, which are incurred by many companies in the regular conduct of their activities, be included in the denominator of the base erosion percentage. Multinational companies, for example, that earn profits in a nonfunctional currency (i.e., currency other than the principal currency of the taxpayer) frequently incur section 988 losses when managing their currency risk by engaging in hedging transactions. Banks and other financial institutions, in turn, enter into section 988 transactions with customers — and thus incur section 988 losses — as part of their trade or business. For these taxpayers, section 988 losses are no different from other types of losses. Also supporting the inclusion of section 988 losses from transactions with unrelated parties in the denominator for purposes of computing the base erosion percentage, OFII further notes that foreign currency transactions may give rise to currency losses that are not “section 988 losses” (e.g., losses on a foreign currency regulated futures contract),¹⁰⁶ which thus would not be excluded from the denominator for purposes of computing the base erosion percentage. In OFII's view, there is no policy reason for Treasury and the IRS to provide a disparate treatment between section 988 losses and other losses deriving from foreign currency transactions or any other losses originating from transactions with third parties.

Additionally, if true economic losses incurred and allowed in the determination of taxable income (such as section 988 losses) are not properly included in the denominator of the base erosion percentage calculation — thus increasing the base erosion percentage and, consequently, the taxpayer's MTI for the year — taxpayers in a loss position would recognize the impact of such non-inclusion more than once in computing its BEAT liability: first, by increasing its MTI in the loss year and then by applying such increased base erosion percentage from such loss year to the NOL in later years. Accordingly, because of the lasting impact of the base erosion percentage on the computation of a taxpayer's BEAT liability amount, OFII believes such types of true economic losses should be included in the denominator of the base erosion percentage.

V. CONCLUSION

We commend Treasury and the IRS for their efforts to address numerous important issues relating to section 59A by issuing the Proposed BEAT Regulations, and appreciate the opportunity to comment thereon. In OFII's view, many aspects of the Proposed BEAT Regulations embody sound tax policy with respect to several issues under section 59A and eliminate arbitrary and unintended disincentives to foreign corporations to engage in activities in the United States.

While OFII believes the Proposed BEAT Regulations provide sound guidance on a wide variety of issues, it also strongly believes that the issues described in this comment letter need be addressed as part of final regulations. We would welcome the opportunity to meet with you to further discuss our comment letter.

Sincerely,

Nancy McLernon
President and CEO
Organization for International Investment
Washington, DC

cc:
L. G. “Chip” Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury Department
Douglas Poms, International Tax Counsel, 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