Banks, Securities Dealers Seek Exceptions From BEAT

August 8, 2018

Mr. David J. Kautter
Assistant Secretary for Tax Policy, and Acting
Commissioner of the Internal Revenue Service
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, DC 20220

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

Mr. William M. Paul
Acting Chief Counsel and
Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, DC 20224

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

Re: Need for De Minimis and Transitory Ownership Exceptions to Special BEAT Rules for Banks and Registered Securities Dealers

Dear Sirs:

New section 59A (the “base erosion and anti-abuse tax,” or “BEAT”) applies on a more onerous basis to affiliated groups that include a bank or registered securities dealer. We respectfully request that Treasury and the Service issue guidance providing for de minimis and transitory ownership exceptions to these special terms for affiliated groups that primarily conduct businesses not involving banking or registered securities dealing, but which include banks or registered securities dealers that either are small relative to the overall group or are members of the group for only a brief period of time during a taxable year.

I. Background

Section 59A(a), as added to the Internal Revenue Code by P.L. 115-97, imposes on each applicable taxpayer for any taxable year a tax equal to the base erosion minimum tax amount for the taxable year. This tax is in addition to any other tax imposed by Subtitle A (Income Taxes).

Section 59A(b)(1) provides that, for purposes of section 59A, subject to modifications in paragraphs (2) and (3), the term “base erosion minimum tax amount” means, with respect to any applicable taxpayer for any taxable year, the excess 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) an amount equal to the regular tax liability of the taxpayer for the taxable year, reduced by various tax credits described in section 59A(b)(1)(B). Section 59A(b)(2) provides modifications for taxable years beginning after 2025.

As relevant here, section 59A(b)(3)(A) provides that, in the case of a taxpayer described in section 59A(b)(3)(B) that is an applicable taxpayer for any taxable year, each tax rate percentage otherwise in effect under paragraphs (1)(A) and (2)(A) is increased by one percentage point. A taxpayer is described in section 59A(b)(3)(B) if the taxpayer is a member of an affiliated group (as defined in section 1504(a)(1)) which includes (i) a bank (as defined in section 581) or (ii) a registered securities dealer under section 15(a) of the Securities Exchange Act of 1934.

The statutory language includes a cliff effect, in that a taxpayer is described in section 59A(b)(3)(B) by reason of the mere presence of any bank or registered securities dealer in the affiliated group, regardless of the size or relative importance of the bank or registered securities dealer in the context of the overall group. Thus, absent exceptions, a taxpayer could be subject to the increased BEAT rate by reason of the affiliated group including a bank or registered securities dealer that is small¹ or a member for a brief period within a taxable year,² regardless of whether those entities themselves make base eroding payments. The legislative history does not explain the intent of the provision. Presumably, the provision is intended to reach affiliated groups in which significant opportunities for, or peculiar harms from, base erosion payments may be thought to exist by reason of the presence of a bank or registered securities dealer in the group. Whatever the policy reason for the different treatment of an affiliated group that includes a bank or registered securities dealer, that policy would not be served by applying the more onerous provisions to cases where the affiliated group holds a bank or registered securities dealer that is very small or holds it only for a brief period.

The definition of “applicable taxpayer” also has a different base erosion threshold if the taxpayer is described in section 59A(b)(3)(B). More specifically, section 59A(e)(1) provides that the term “applicable taxpayer” means, with respect to any taxable year, a taxpayer which meets the following three conditions: (1) the taxpayer is a corporation other than a regulated investment company, a real estate investment trust, or an S corporation, (2) the average annual gross receipts of the taxpayer for the 3-taxable-year period ending with the preceding taxable year are at least $500,000,000, and (3) the base erosion percentage (as determined under section 59A(c)(4)) of the taxpayer for the taxable year is 3 percent (2 percent in the case of a taxpayer described in section 59A(b)(3)(B)) or higher. Thus, absent exceptions, a taxpayer could be subject to the lower base erosion threshold in section 59A(e)(1) by reason of the affiliated group having a bank or registered securities dealer that is either small or a member of the group for only a brief period of time.

As noted above, the legislative history provides no policy explanation for this provision, and Treasury is left with the task of issuing regulations that make sense and are consistent with the implicit policy of an increased base erosion minimum tax rate or a reduced base erosion threshold based on the presence of a bank or registered securities dealer in an affiliated group. De minimis and transitory ownership exceptions would avoid applying these special rules in situations in which no discernible policy basis exists for their application, while preserving the likely intended reach of the rules. The absence of such exceptions could create traps for the unwary, and could lead wary taxpayers to dispose of very small banks or registered securities dealers in order to avoid these issues, incurring needless costs and delaying deals. We see no policy reason to preserve these traps for the unwary, nor to incentivize dispositions of very small financial entities. As discussed below, Treasury and the Service in similar situations have seen fit to address cliff effects through regulation.

II. Request for De Minimis and Transitory Ownership Exceptions

We respectfully request that Treasury and the Service issue guidance providing for two exceptions to the special taxpayer status described in section 59A(b)(3)(B). The first exception could be a size-based de minimis exception and provide that a taxpayer is not described in section 59A(b)(3)(B) if the aggregate gross receipts from all banks and registered securities dealers described in section 59A(b)(3)(B) are less than a specified percentage of gross receipts (e.g., 5 percent) of the affiliated group's gross receipts. An exception based on gross receipts should be more administrable and less manipulable than one based on gross income, assets, or employees, and could rely on the gross receipts concept already used in section 59A for other purposes.

The second exception could be a time-based transitory ownership exception and provide that a taxpayer is not described in section 59A(b)(3)(B) if a bank or registered securities dealer was disposed of, or was subject to a binding written contract to be disposed of, by an affiliated group within a specified period of time (e.g., within 90 days³ in a taxable year).⁴ This would provide time for an acquiring affiliated group to dispose of the bank or registered securities dealer without the affiliated group becoming subject to the increased rate of tax under section 59A(b)(3)(A).

In order to protect the policy of the special rule for banks and registered securities dealers, Treasury and the Service could provide that the increased rate set forth in section 59A(b)(3)(A) would continue to apply with respect to the banks and registered securities dealers themselves (just not to the entire affiliated group). In addition, Treasury and the Service could provide an anti-abuse rule to prevent a member of the group that is not a bank or registered securities dealer from making payments to related foreign parties for, on behalf of, or in lieu of a payment by, a bank or registered securities dealer.

The proposed exceptions should have the same effective date as that of section 59A itself (i.e., effective for base erosion payments paid or accrued in tax years beginning after December 31, 2017).

III. Regulatory Authority

Treasury has the authority to provide for these exceptions under section 7805.⁵ More specifically, Treasury has authority to construe section 59A(b)(3)(B) logically by providing limited exceptions in regulations under the authority of section 7805, even in the absence of statutory language explicitly authorizing such exceptions.

Treasury and the Service have, on numerous occasions, provided analogous exceptions to avoid applying rules in situations not presenting any policy basis for their application, while preserving the intended reach of the rules. Treasury and the Service have provided several size-based de minimis exceptions under the authority granted under section 7805, even in the absence of explicit statutory authority.⁶

In addition, in the section 956 context, time-based exceptions to the definition of “obligation” have been provided through Treasury guidance for most of the history of section 956, even though section 956 itself includes no express authorization of any time-based exception. The first set of section 956 regulations, issued under the authority granted under section 7805, excluded from the definition of an “obligation” certain debt obligations that are collected within one year.⁷ When these regulations were withdrawn,⁸ Treasury and the Service then issued Notice 88-108, which excluded from the definition of “obligation” certain obligations that are collected within 30 days, as long as the CFC does not have loans to related U.S. persons outstanding during the year for 60 or more days (the 30/60 day exception). Treasury and the Service later issued regulations⁹ that included the 30/60 day exception (as modified by subsequent Notices¹⁰).

These exceptions show that Treasury and the Service have long exercised the general regulatory authority under section 7805 to avoid cliff effects by providing size- or time-based exceptions in a range of different contexts when appropriate to carry out the purposes underlying the corresponding legislation. We respectfully request that a similar approach be taken to prevent the application of the enhanced BEAT provisions in situations not implicating the policy of those provisions.

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We appreciate your consideration of our comments.¹¹ We would be happy to discuss any questions you may have.

Sincerely,

Robert H. Dilworth
P.O. Box 40813
Washington, DC 20016
rhdilworth@rdilworth.com

Matthew A. Lykken
P.O. Box 40813
Washington, DC 20016
mlykken@potomaclaw.com

Caroline H. Ngo
McDermott Will & Emery LLP
500 North Capitol St., NW
Washington, DC 20001
cngo@mwe.com

David G. Noren
McDermott Will & Emery LLP
500 North Capitol St., NW
Washington, DC 20001
dnoren@mwe.com

Jeffrey M. O'Donnell
P.O. Box 40813
Washington, DC 20016
jmodon888@gmail.com