Group Lists Administrative, Interpretive Guidance Needed for BEAT

July 17, 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, D.C. 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, D.C. 20220

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

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

Re: Section 59A

Dear Sirs:

The Organization for International Investment (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 increases 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 2016, there was almost $3.7 trillion of cumulative foreign direct investment in the United States. This investment supports more than 24 million workers in the United States, including 6.8 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 24 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 foreign direct investment. 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 foreign direct investment involved.¹

I. Executive Summary

On December 22, 2017, the Tax Cuts and Jobs Act (the “TCJA” or “Act”) was enacted.² The Act made significant changes to the U.S. tax system and added several new provisions, including section³ 59A of the Code (commonly referred to as the “Base Erosion and Anti-Abuse Tax” or “BEAT”). The BEAT raises many issues both administrative and interpretative. To assist Treasury and the IRS to sort out the urgency and need for guidance, OFII and its members have identified the following issues under the BEAT that have the most significant and immediate impact to our members:

• The services cost method (“SCM”) exception in section 59A(d)(5) should be interpreted consistent with the legislative history and therefore only the markup should be treated as a potential base erosion payment as defined in section 59A(d) (a “Base Erosion Payment”).

• A taxpayer should not be required to maintain separate accounts to bifurcate the cost and markup components of a service charge. 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) should be excluded from the SCM exception. Accordingly, taxpayers should be able to utilize the SCM exception regardless of whether the services constitute a fundamental element of the taxpayer's core business.

• With respect to intermediary payments, the determination of whether a payment is a Base Erosion Payment should be made by looking through the foreign related party that receives the payment to the ultimate intended recipient of the payment. This approach would more accurately capture the types of payments that Congress was concerned about and would minimize the impact of BEAT on ordinary business transactions where cash flows through a foreign related party are based on administrative and practical considerations.

• Gross payments made and received by a taxpayer may be netted and accounted for consistently to the extent that the payments are connected with or to the same product, service, or business activity.

• Consistent with Treas. Reg. § 1.482-7(j)(3)(i), a deductible cost sharing payment made by a U.S. controlled participant to a foreign controlled participant should not be a Base Erosion Payment to the extent it reflects a reimbursement of amounts that the foreign participant paid or incurred to unrelated parties.

• The base erosion percentage that applies is the percentage in the year in which an NOL arose rather than the year the NOL is utilized. Using the base erosion percentage in the year the NOL arose would align the amount of the modified taxable income addback attributable to an NOL deduction with the Base Erosion Payments that contributed to the creation of the loss.

• Excluding pre-enactment NOLs from BEAT is consistent with the effective date of the BEAT provision to not apply to Base Erosion Payments (or losses attributable to such payments) that were paid or accrued in tax years beginning before January 1, 2018.

• Taxable income can be reduced below zero due to a current year operating loss or as a result of an NOL deduction attributable to losses arising in taxable years beginning before 2018. This treatment is consistent with section 172 prior to its amendment under the Act where the amount of the NOL deduction is the aggregate amount of the NOL carryover and carryback for the taxable year.

Additionally, OFII and its members have also identified the following interpretative issues and recommendations where guidance will be helpful for taxpayers in applying the provision:

• For related U.S. entities with a single tax filer (e.g. a single U.S. consolidated group), the base erosion minimum tax amount should be determined at the tax filer level. Thus, a U.S. consolidated group should only have one base erosion minimum tax amount and such amount should be computed at the consolidated level. 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)).

• Additionally, given that section 59A determines an “applicable taxpayer” on an aggregated group approach, and where multiple U.S. tax filers exist, OFII believes that it is appropriate to take into account the operations of multiple related U.S. tax filers as a single economic unit and that guidance should also provide that the section 59A tax liability may be computed on an aggregated group basis.

• The definition of modified taxable income should be computed based on an “add-back” approach similar to section 163(j). An add-back approach is consistent with the statutory text and would be the most administrable.

• Payments between U.S. and foreign members of an aggregated group should be disregarded for purposes of computing both the gross receipts and the base erosion percentage. Accordingly, payments among U.S. and foreign corporations held by a common foreign parent should be disregarded. Similarly, payments from a U.S. corporation to a foreign corporation that is engaged in a U.S. trade or business either directly or through a U.S. branch, and that is a member of the same controlled group as the U.S. corporation should be disregarded.

• Foreign corporations that are subject to U.S. federal income tax on a net basis should not be treated as receiving a base eroding payment since the policy concern that led to the enactment of section 59A simply does not exist (i.e., a U.S. corporation eroding its base by making payments to foreign related persons that are subject to little or no U.S. federal income tax).

• Payments that are made to a controlled foreign corporation that are includible by a U.S. shareholder for purposes of section 951(a) or section 951A should not be treated as a Base Erosion Payment since the payments are subject to U.S. federal income tax at the U.S. shareholder level.

• Guidance should provide an exclusion for deductible payments made by an applicable taxpayer that are paid in accordance with a bilateral advance pricing agreement (APA) from being treated as a base erosion tax benefit as these amounts do not raise base erosion concerns.

• Treasury and the IRS should issue guidance applying an aggregate approach to partnerships so that determinations with regard to the BEAT provisions are made at the partner level.

II. Detailed Discussion of Requested Guidance for Priority Issues

A. Issues Related to the Services Cost Method Exception

1. The Services Cost Method Exception Should Apply Regardless of Whether There is a Markup Component

Section 59A(d)(5) provides an exception to the definition of Base Erosion Payment for any amount paid or accrued by the taxpayer for services, provided that (A) the services are eligible for use of the SCM under Treas. Reg. § 1.482-9(b) (determined without regard to the requirement that the services not contribute significantly to the fundamental risks of business success or failure),⁴ and (B) such amount constitutes the total services cost with no markup component.

There is much uncertainty regarding the scope of the SCM exception, in particular, whether a service charge that includes a markup component continues to be eligible for the SCM exception to the extent of the cost component. A straightforward application of the statutory text would conclude that the cost component is eligible for the SCM exception since it applies to “any amount” paid or accrued by the taxpayer provided “such amount constitutes the total services cost with no markup component.” To the extent that there is also a markup component included in the service payment, the markup component may constitute a Base Erosion Payment.

Both the United States and a foreign jurisdiction would expect a markup component for services if charged at arm's length under generally recognized transfer pricing principles.⁵ Interpreting the SCM exception in a manner that only applies to charges that do not have a markup component would largely render the SCM exception meaningless and would put tension on generally recognized transfer pricing principles (including arm's length principles under an applicable U.S. income tax treaty). Essentially, a taxpayer would be forced to choose between applying the SCM exception (and not include a markup) or comply with an arm's length standard and include a markup. Part of the policy underlying Section 59A was to target taxpayers who are eroding the U.S. tax base. The cost component of a service charge simply reflects the cost of doing business. It is difficult to see how the cost of doing business could be viewed as eroding the U.S. tax base.⁶

On December 1, 2017 (before enactment, but after the Senate amendment was released), Senator Portman (R-OH) and Senate Committee on Finance Chairman Hatch (R-UT) discussed the intended scope of the SCM exception on the Senate Floor.

Senator Portman stated the following:

I would like to clarify a point in connection with the application of the base erosion anti-abuse tax in the Tax Cuts and Jobs Act to services companies. The act provides an exception from the base erosion anti-abuse tax for services. The act limits the exception to the “total services cost with no markup." As a practical matter, companies account for amounts paid or accrued for services in a variety of ways. I would like to clarify that, if in a transaction a company used one account for services cost with no markup and another accounted for any additional amounts paid or accrued, that the first account would be subject to the exception under the bill.

To which Chairman Hatch responded:

The Senator is correct. The intent of the provision is to exclude all amounts paid or accrued for services costs with no markup. Thus amounts paid or accrued in that account would be excluded from the base erosion anti-abuse tax. Other accounts related to the same transaction may or may not be excepted from this tax.

This colloquy demonstrates that Chairman Hatch (who was the Senate floor manager of the bill) and Senator Portman believed that if a company could delineate its service charge between the amount constituting the cost and the amount constituting the markup, then the cost component, which essentially reflects a reimbursement to the service provider, should not be a Base Erosion Payment. The markup, in contrast, could be a Base Erosion Payment. OFII believes that the statements accurately reflect the scope of the SCM exception (i.e., it was intended that the cost component not be treated as a Base Erosion Payment) and urges that guidance be issued to clarify that a service payment that includes a markup will continue to be eligible for the SCM exception to the extent that taxpayers can identify both the cost component and the markup component.

We understand that another possible interpretation of the statutory text is that “any amount” paid or accrued by the taxpayer for services is a reference to the total amount paid for the total services, and if there is a markup component, then the entire amount of the payment (including the cost component) will not be eligible for the SCM exclusion.⁷ However, this interpretation creates a cliff effect for SCM eligibility where one dollar of a markup will cause the entire payment to be treated as a Base Erosion Payment. This cliff effect does not seem to serve any clear policy objective to implementing the provision and would have a punitive effect for global companies that frequently rely on low-margin services of foreign affiliates.

The example below, provided by one of our members, demonstrates how taxpayers can be adversely impacted by a narrow interpretation of the SCM exception.

Our member is a foreign-parented multinational company with U.S. subsidiaries that operates a worldwide freight business. Under a global contract, all members of the global group cooperate and utilize one another in moving freight for third-party customers internationally. For example, assume a U.S. customer requires a freight movement from Japan to the United States. The U.S. affiliate uses its Japanese affiliate to arrange the freight movement to the Japanese port, then from the Japanese port to the U.S. port. The U.S. affiliate arranges the freight movement from the U.S. port to the required location in the United States. The U.S. customer will make a single payment to the U.S. affiliate and the U.S. affiliate will need to make a payment to the foreign affiliate for the foreign services that are performed. If the service provided by the foreign affiliate qualifies as a “low margin service” (i.e., the arm's length markup is seven percent or less), then the cost component of the service charge should be excluded as a Base Erosion Payment under the SCM exception.

Due to the nature of global businesses, the use of a foreign service provider to perform services to fulfill a contract will be necessary. Many service companies (both inbound and outbound) would be at a competitive disadvantage where, for example, a U.S. affiliate could contract with an unrelated foreign party and the payment for such services would not be a Base Erosion Payment. Treating payments to low margin service providers as Base Erosion Payments will not only increase costs to customers, but could also result in effective tax rates in the triple digits, and have the effect of converting a large, low-margin business into a loss-generating business. This may also cause many companies to use unrelated foreign service providers to mitigate the impact of BEAT which does not seem to further any clear policy objective. For global businesses that rely on the services of their foreign affiliates, where an arm's length price is paid, the ability to exclude the cost component of an eligible service under the SCM exception would mitigate the impact of section 59A to prevent what would otherwise be a profitable business from turning into a loss-generating business.

Accordingly, Treasury and the IRS should provide guidance clarifying that when a markup is paid for an eligible service, the cost component of the service charge is not treated as a Base Erosion Payment under the SCM exception.

2. Separate Accounts Should Not Be Required

Although OFII believes that the above colloquy demonstrates the legislative intent of the SCM exception, we do not believe that taxpayers should be required to formally maintain two separate accounts to bifurcate the cost component and the markup component of a service charge. Requiring taxpayers to keep separate accounts in order to qualify for the SCM exception would create a significant administrative burden on how taxpayers conduct their business. Notably, there is no mention of keeping separate accounts in the statutory text of the SCM exception.

Furthermore, in order to qualify for the SCM under section 482 regulations, (and therefore the SCM exception) a taxpayer is required to maintain books and records that identify the “total service cost associated with the services.”⁸ Thus, a books and records requirement is already built into the SCM exception. Accordingly, requiring a taxpayer to keep additional books and records solely for the SCM exception would be redundant. The books and records requirement under the section 482 regulations should adequately address any concerns raised by the Senators in their colloquy since taxpayers are already required to separately identify the service cost component.

Finally, since the taxpayer bears the burden of proof on audit of distinguishing between the cost and the markup portion of the payment, the government would not derive any additional benefit by requiring taxpayers to maintain separate accounts.

3. The SCM Exception Eliminates the Business Judgment Rule

As described above, a Base Erosion Payment will not include any payment for services that qualify for the SCM exception. A service is eligible for the SCM if it satisfies “the requirements for eligibility for the use of the services cost method (determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure).”⁹

Treas. Reg. § 1.482-9(b)(2) generally requires that services meet four requirements to be eligible for the SCM exception:

To apply the services cost method to a service in accordance with the rules of this paragraph (b), all of the following requirements must be satisfied with respect to the service —

(i) The service is a covered service as defined in paragraph (b)(3) of this section;

(ii) The service is not an excluded activity as defined in paragraph (b)(4) of this section;

(iii) The service is not precluded from constituting a covered service by the business judgment rule described in paragraph (b)(5) of this section; and

(iv) Adequate books and records are maintained as described in paragraph (b)(6) of this section.

As noted above, however, for purposes of section 59A, Treas. Reg. § 1.482-9(b)(2)(iii) (referred to as the business judgment rule) is not required to be satisfied in order for payments made for such services to be excluded as Base Erosion Payments.

Treas. Reg. § 1.482-9(b)(5) provides the following:

A service cannot constitute a covered service unless the taxpayer reasonably concludes in its business judgment that the service does not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure in one or more trades or businesses of the controlled group.

The SCM exception specifically eliminates the requirement that the services not contribute significantly to fundamental risks of business success or failure even though the statutory text does not restate Treas. Reg. § 1.482-9(b)(5) in its entirety. The Conference Report clarifies that “a Base Erosion Payment does not apply to any amount paid or accrued by a taxpayer for services if such services meet the requirements for eligibility for use of the [SCM] described in Treas. Reg. § 1.482-9, as in effect as of the date of enactment of TCJA, without regard to the requirement that the services not contribute significantly to the fundamental risks of business success or failure . . . ”¹⁰

OFII requests that guidance confirm that the SCM exception is available for amounts paid or accrued for services that would otherwise meet the SCM requirements in Treas. Reg. § 1.482-9(b) even though the services contribute to key competitive advantages, core capabilities, or fundamental risks of success or failure of a trade or business of the taxpayer (and thus would not satisfy the requirement in Treas. Reg. § 1.482-9(b)(2)(iii)).

B. Look Through Approach for Payments by or to an Intermediary, Reimbursements, and Revenue Share

1. Payments Involving Intermediaries

The mere fact that a payment is made by a U.S. taxpayer to a foreign related party should not be dispositive of whether the payment is a base eroding payment. Where an applicable taxpayer is making a payment to a foreign related party and the foreign related party is receiving a payment as an intermediary on behalf of a third party, even though the applicable taxpayer may be entitled to a deduction for the payment, the guidance should provide that the determination of whether the amount paid by the applicable taxpayer is a Base Erosion Payment is made by treating the payment as if it were made directly by the applicable taxpayer to the person who received the payment from the intermediary. For example, assume A is an applicable taxpayer and makes a deductible payment to B, a foreign related party. B receives the payment on behalf of C, an unrelated third party. The payment from A to B should not be a Base Erosion Payment since B is acting as an intermediary for C, a party unrelated to A.

Similarly, where an applicable taxpayer makes a payment to a foreign related party but the applicable taxpayer is acting as an intermediary for the foreign related party, the payment should not be treated as a Base Erosion Payment. In this case, guidance should clarify that the determination of whether an amount is a Base Erosion Payment is made by treating the payment made by the intermediary as if the payment were made directly by the person who paid the intermediary and to the person for whom the intermediary is acting and remitting the payment to. For example, assume B, an applicable taxpayer receives a payment from A. B receives the payment from A on behalf of C, a foreign party that is only related to B. The payment from B to C should not be a Base Erosion Payment since B is acting as an intermediary for C, a party unrelated to A. If C were a foreign party that was related to A, then the payment from B to C would be a Base Erosion Payment.

Thus, in the case of a payment made by or to an intermediary, we request that guidance provide that the determination of whether the payment is a Base Erosion Payment be made by disregarding the intermediary and treating the payment as if it were made directly by the person who paid the intermediary to the person for whom the intermediary is acting. This approach would be consistent with regulations under the withholding tax provisions of sections 1441 and 1442, which generally provide that in the case of a payment by a withholding agent to a person who is acting as an agent or intermediary for another person, the withholding agent should treat the payment as made directly to the person for whom the agent or intermediary is acting.¹¹ We believe that this type of guidance will more appropriately capture the types of payments that are the intended target of the base erosion provision without unduly impacting ordinary cash flows and systems within a multinational companies.

2. Reimbursements

Additionally, consider a payment made as a reimbursement to a foreign related party where the amount advanced by the foreign related party for the taxpayer was paid to an unrelated party. In such a case, the foreign related party (i.e., the reimbursed party) pursuant to judicial doctrines on reimbursement would not have been entitled to a deduction for the advance and would not be required to recognize the reimbursed amount as income when such amount is paid by the taxpayer.¹² Instead, the taxpayer would be entitled to the deduction, and we believe that in this case, the deduction should be treated as a base erosion tax benefit only to the extent that the reimbursed payment would have been a Base Erosion Payment if made directly by the taxpayer to the person that received the advance by the foreign related party.

As such, we do not believe that the cash flow of the reimbursement to a foreign related party should be viewed as a Base Erosion Payment. OFII recommends that guidance clarify the treatment of payments made pursuant to an advance or other arrangement requiring reimbursement. In an example like the one above, guidance should provide that the determination of whether such amounts are Base Erosion Payments should be made by looking through (or ignoring) the reimbursed party and by analyzing the payment as if the taxpayer directly paid the person who received the amount advanced by the reimbursed party.

3. Revenue Share Payments

Finally, we request Treasury and the IRS issue guidance where certain payments made to a foreign related party that reflect a pass through of a revenue share from services rendered to a third party would not be treated as a base eroding payment. Returning to the freight movement example above where the U.S. affiliate is receiving the full payment from the third-party customer and paying a share to the foreign affiliate for the services they perform, it would be appropriate to consider that the services rendered by the foreign affiliate are not rendered to the U.S. affiliate, but rather to its customer. The U.S. affiliate is acting as the arranging party for the coordinated provision of services to the customer. Thus, where payments made to a foreign affiliate are substantively a revenue share from the coordinated delivery of a product or service to a customer, there should be guidance providing taxpayers the opportunity to establish to the satisfaction of the Secretary that payments made with respect to such transactions are not base eroding.

These approaches to analyzing a Base Erosion Payment would more accurately capture the types of payments that Congress was concerned about in enacting section 59A, would take into account both the legal and substantive arrangement involved rather than mere cash flows, and would prevent the application of BEAT to ordinary business transactions where the cash flows through a foreign related party reflect administrative and practical considerations.¹³

C. Payment Netting

OFII recommends Treasury and the IRS provide guidance that in determining the amount of a Base Erosion Payment, gross payments made by the taxpayer may be netted with gross payments received by the taxpayer to the extent that the payments are connected with or to the same product, service, or business activity. Determining the amount of a Base Erosion Payment on a net-payment basis as opposed to gross-payment basis more closely aligns to the economics of the various charges that flow within a multinational group of companies. Determining the amount of Base Erosion Payments on a gross basis would also add an administrative burden, as many of our members may need to revamp internal accounting systems and the way they do business.

The following scenarios have been identified by OFII members to highlight how they are negatively and unduly impacted by having to compute the amount of a Base Erosion Payment on a gross basis instead of a net basis when the payments are related to the same product, service or business activity:

• Companies that both receive payments and make payments often recognize only the net amount for purposes of U.S. tax reporting. This is often the case where services are provided between various related parties and the U.S. company acts as a global clearinghouse under agency theory or a prime contractor/subcontractor model.

• Some of our members utilize a recharge process for the company's global service agreements (GSAs). The process involves sending the U.S. company's service charges to a non-U.S. clearing house, which collects the service charges from other countries as well. The costs are analyzed, and the appropriate markups determined, after which the U.S. company receives back its portion of the GSA charges. For some companies, the U.S. company is a net service provider, meaning that it charges out more costs than it receives. However, from a gross perspective, the charge sent back to the U.S. company could cause a large BEAT liability where, economically, there was no base erosion and therefore, as a policy matter, there should be no BEAT liability at all.

• To minimize wire transfers and ease the administrative burden of reconciling intercompany balances and intercompany charges to and from a U.S. and a foreign party, payments are frequently netted and cash settled on a monthly basis.

• U.S. Operating Co. licenses technology from its non-U.S. affiliates and also conducts its own substantial R&D in the United States. The resulting technology, which includes U.S. developed IP and foreign developed IP, is then licensed by U.S. Operating Co. to U.S. and non-U.S. affiliates for use in manufacturing operations. This approach works well for business purposes and has the effect of increasing the U.S. tax base. To reflect the economics of the relationship, the royalty income from outbound licensing of the product and manufacturing technology should be netted against the royalty expense for inbound licensing of the product and manufacturing technology in determining the amount of the Base Erosion Payment.

• In one member's freight forwarding business, the global network of affiliates agree to service customers on a reciprocal basis. Generally, an international freight movement has three legs: origin country, international leg and destination country. Each affiliate handles its local country leg and the international leg is procured by one or the other, depending on circumstances. The third party revenue gets billed by and booked at the affiliate with the local customer relationship. Under the agreement, the origin country ultimately gets its local country leg and the international leg gross revenue (via intercompany revenue/expense accounts in cases where the destination country was also the billing country — to move the international leg revenue to the origin country) and then pays a tariff on the international leg to the destination. Thus, the destination entity receives revenue for its local leg and a tariff on the international leg. All of this is accumulated on a monthly basis via an internal clearing house, and the tariff amounts are netted, while the initial move of international revenue is booked gross. The netting is done because it greatly simplifies the accounting to a once-a-month entry for tariffs between the same two countries (e.g., netting of tariffs for the month from the United States to France and France to the United States) rather than an endless set of entries for thousands of daily transactions around the world.

As section 59A is currently written, taxpayers may be unduly harmed by considering only the gross outbound charge. In these circumstances, only a net outbound amount paid or accrued from the United States should be considered as the amount of the Base Erosion Payment. The netting of payments provides a more realistic accounting of payments within a multinational group of companies, and therefore should be adopted to determine the amount of Base Erosion Payments.

D. Cost Sharing Arrangements

Guidance is requested to clarify the application of section 59A to payments made pursuant to a cost sharing arrangement. A cost sharing arrangement allows controlled participants to share in the costs and risks of developing a cost shared intangible in proportion to their reasonably anticipated benefits. In the case of intangibles that are developed pursuant to a cost sharing arrangement, the regulations provide that a controlled participant must make a cost sharing payment to another controlled participant to the extent necessary to achieve the appropriate sharing ratio. Under Treas. Reg. § 1.482-7(j)(3)(i), such a cost sharing payment is treated as the payor's cost of developing intangibles and is deemed to reduce the deductible intangible development costs of the payee. Thus, the regulation mandates that such a payment be treated as a reimbursement of an advance by the payee. See also the discussion above in section II.B.2 related to reimbursements.

As a result, OFII recommends that Treasury and the IRS provide guidance consistent with Treas. Reg. § 1.482-7(j)(3)(i) that a deductible cost sharing payment made by a U.S. controlled participant to a foreign controlled participant is not a Base Erosion Payment to the extent it reflects a reimbursement of amounts that the foreign participant paid or incurred to unrelated parties.

E. Issues Related to the Use of NOLs

1. The Base Erosion Percentage of an NOL Should Be the Percentage That Applies in the Year the NOL Arose

In computing modified taxable income (“MTI”), a taxpayer must “add back” to taxable income the base erosion percentage of any NOL deduction allowed under section 172 for the taxable year. The amount of a taxpayer's NOL deduction with respect to losses arising in tax years beginning after December 31, 2017 is equal to the lesser of the total available NOL carryover or carrybacks to such taxable year or 80 percent of a taxpayer's taxable income computed without regard to the NOL deduction. For an NOL deduction with respect to losses arising in tax years beginning before December 31, 2017, the amount of the NOL deduction is not subject to the limitation based on taxable income described above. Thus, a taxpayer's NOL deduction for pre-2018 taxable year losses could offset 100 percent of taxable income.

While the statutory language in section 59A outlines the mechanics to determine the base erosion percentage that applies for a taxable year, for purposes of determining the amount of the MTI addback related to an NOL deduction, there is uncertainty as to whether the base erosion percentage that applies to the NOL deduction allowed for the taxable year is the percentage that applies in the year the NOL arose or the year the NOL is utilized.

The legislative history is silent on this point and simply describes the high-level mechanics:

To determine its modified taxable income, the applicable taxpayer computes its taxable income for the year without regard to any base erosion tax benefit with respect to any Base Erosion Payment or the base erosion percentage of any allowable net operating loss deduction allowed under section 172 for the taxable year.¹⁴

OFII recommends that guidance provide that the base erosion percentage that applies is the percentage in the year in which the NOL arose rather than the year the NOL is utilized. Using the base erosion percentage in the year the NOL arose would align the amount of the MTI addback attributable to an NOL deduction with the Base Erosion Payments that contributed to the creation of the loss, unlike applying the percentage in the year the NOL is utilized. Moreover, it prevents the NOL from being potentially subject to two unrelated limitations: (1) in the year the NOL arose where the NOL is reduced by addback of the related party payments in calculating the BEAT and (2) a second limitation in the year the NOL is utilized using the base erosion percentage for that particular year. Finally, if the base erosion percentage that applies is the percentage in the year the NOL is utilized rather the year it arose, it would make it difficult for taxpayers to estimate a tax asset value for financial accounting purposes associated with their NOLs in light of changing base erosion percentages in any given taxable year.

Assuming the year the NOL arose approach is adopted, guidance should also clarify that the base erosion percentage that applies to an NOL deduction attributable to losses arising in taxable years beginning before December 31, 2017, is zero because there would not be any Base Erosion Payments occurring before such date.¹⁵ Should guidance adopt the approach to apply the base erosion percentage in the year the NOL arises then the result of that approach would also effectively be the same as excluding NOL deductions allowed under section 172 attributable to losses arising in tax years beginning before January 1, 2018 (“pre-2018 NOLs”) from the MTI add-back.

2. Pre-2018 NOLs Should Be Specifically Excluded from the Add-back

OFII recommends that guidance provide that pre-2018 NOLs should be specifically excluded from the amount that may be added back for purposes of computing MTI. Excluding pre-enactment NOLs from being added back to MTI is consistent with the effective date of the BEAT provision to not apply to Base Erosion Payments (or losses attributable to such payments) that were paid or accrued in tax years beginning before December 31, 2017. Additionally, section 172 does not treat an NOL carryover or carryback as an amount paid or accrued in a subsequent year when determining the amount of an NOL carryover and carryback for a given tax year. Thus, pre-2018 losses should not be subject to BEAT since they, by definition, are not attributable to any Base Erosion Payments.

Notably, the Act's amendments to section 172 to impose more restrictive limits on the amount of the NOL deduction do not apply to deductions attributable to NOLs arising in taxable years beginning before 2018. If Congress had intended for pre-2018 NOLs to be subject to the amendments made to section 172 of the Act, it would have specifically done so through statutory language included in the Act. By not subjecting pre-2018 NOLs to the new NOL limitation, we believe that Congress understood the importance of preserving the value of these NOLs. Consequently, taxpayers who have pre-2018 NOLs should continue to get a 100 percent benefit from their prior operating losses and such losses should not be included in the MTI calculation. Accordingly, we request that guidance provide that pre-2018 NOLs be specifically excluded from being added back to MTI.

3. Taxable Income May Be Reduced Below Zero for Pre-2018 NOLs

The starting point for calculating MTI is taxable income, which is not specifically defined in section 59A. In general, taxable income is defined in section 63(a) to mean gross income minus the deductions allowed by chapter 1.

Prior to amendment by the Act, former section 172(a) provided that “there shall be allowed as a deduction for the taxable year an amount equal to the aggregate of (1) the net operating loss carryovers to such year, plus (2) the net operating loss carrybacks to such year.” As a result, the amount of the allowed NOL deduction with regards to a pre-2018 loss was the total of all NOL carryovers and carrybacks to a given tax year — not capped by taxable income, in contrast to amended section 172.

Treas. Reg. § 1.172-1(b) prescribes the steps in computing the NOL deduction for any taxable year. The regulations provide that the NOL deduction is the total NOL carried back to a year even if it is in excess of positive taxable income. Treas. Reg. § 1.172-6(d) contains an example of the application of NOL carrybacks and carryovers, and explicitly indicates that both the NOL carryback and NOL deduction for 1954 are $75,000, despite the fact that taxable income prior to the carryback is only $15,000.

Former section 172 and the regulations thereunder indicate that a pre-2018 NOL is the aggregate of the NOL carryforwards and carrybacks to a given taxable year. As such, the “taxable income” starting point, as defined in section 63(a), would be gross income minus (among other deductions) the aggregate of pre-2018 NOL carryovers and carrybacks to a given year. It follows then that taxable income may be reduced below zero as a result of an NOL deduction for pre-2018 NOLs. As such, we recommend that Treasury and the IRS clarify in guidance that taxable income may be reduced below zero by an NOL deduction attributable to a pre-2018 NOL. Guidance should also clarify that the analysis for an NOL deduction attributable to pre-2018 NOLs to reduce taxable income below zero applies in each subsequent year that a pre-2018 NOL may carryover to.

4. Taxable Income May Be Reduced Below Zero for Current Year Operating Losses

There is no indication in either section 59A or the legislative history that taxable income cannot be reduced below zero to the extent there is a current year operating loss. Notably, when determining an applicable taxpayer's BEAT liability, the taxpayer must take into account its regular tax liability, reduced (but not below zero)¹⁶ by certain credits. Thus, it seems that Congress did consider that certain items, namely those particular credits, could not reduce taxable income below zero within the context of Section 59A, but was otherwise silent with respect to whether other items, like operating losses, could reduce taxable income below zero.¹⁷ Had Congress intended for taxable income to not be reduced below zero with regards to other items, OFII believes that there would have been a clear expression of that intent either in the statute or the legislative history as there was with specified credits that were enumerated in the statute.

Allowing taxable income to be reduced below zero based on the definition of section 63(a) would be consistent with other provisions where taxable income is the starting point for a computation. For example, the starting point for computing adjusted taxable income under section 163(j)(8) is taxable income. While section 163(j)(1) clearly states that adjusted taxable income cannot be below zero, the statute is silent regarding taxable income. Thus, the only appropriate way to interpret both section 59A and section 163(j) is to interpret, taxable income in a manner consistent with section 63.

III. Detailed Discussion of Other Issues

A. Computing the BEAT Liability

In order to compute an applicable taxpayer's BEAT liability under section 59A, the taxpayer must compare whether its MTI multiplied by the BEAT rate applicable for the taxable year exceeds its regular tax liability for the taxable year reduced (but not below zero) by certain credits. The taxpayer's regular tax liability is defined by reference to section 26(b). Thus, a U.S. corporation's regular tax liability is the amount of U.S. federal income tax imposed under section 11 and a foreign corporation's tax liability is the amount of tax imposed under section 882. The regular tax liability is reduced by the excess of credits allowed under chapter 1 over the sum of the section 38 credits allowed as a research credit plus a portion of the section 38 credits allowed that are allocable to the energy credit. The fact that regular tax liability is reduced only by certain credits, allows taxpayers to continue to benefit from only certain credits when computing the BEAT liability. It is noteworthy that foreign tax credits are not preferred credits and can be effectively denied by section 59A. Given that foreign tax credits are only allowed to reduce U.S. regular tax liability when the item of foreign source income is already included in U.S. taxable income, denying such credits is at complete odds with the purpose of preventing base erosion. Instead of limiting the provision to certain credits, all credits should be allowed in computing the BEAT liability.¹⁸

While the framework for computing the BEAT liability may seem relatively straight-forward, there is uncertainty as to whether the tax imposed under section 59A should be computed on a single entity approach, a consolidated group approach, or an aggregated group approach. For the reasons discussed below, OFII recommends that guidance clarify that the tax imposed under section 59A (i.e., the BEAT liability) should be determined on a consolidated group basis as opposed to a single entity basis where related U.S. entities are members of a single U.S. consolidated group. Additionally, where multiple U.S. tax filers exist, we believe that it is appropriate to take into account the operations of multiple related U.S. tax filers as a single economic unit by issuing guidance that applies section 59A on an aggregated group basis as described below.

1. For Related U.S. Entities in a Single Consolidated Group, the BEAT Liability Should Be Computed at the Consolidated Group Filer Level

A consolidated group has a “regular tax liability” under section 26(b), which generally means the consolidated group liability.¹⁹ Using a consolidated group approach to compute a taxpayer's BEAT liability follows the consolidated group principles throughout the Code. A consolidated group within the meaning of Treas. Reg. § 1.1502-1(h) is comprised of members²⁰ which are required to file a consolidated group return for a given tax year. NOLs for a U.S. consolidated group are computed on a consolidated group basis and reported on the consolidated group return.²¹ As NOLs are a critical component in computing the BEAT liability, calculating NOLs and BEAT tax liability on a consolidated basis would make computing the BEAT liability more efficient and streamline reporting when compared to computing NOLs on a single entity basis.

Furthermore, as each entity does not have its own tax liability, using a predefined group with a defined liability under section 26(b) provides an administrable starting point. In particular, the consolidated return regulations already set forth a comprehensive regime governing transactions between members and computing a consolidated group's tax liability, including elections binding on all members of the group, based on that regime.²² Therefore, performing the BEAT calculation at the consolidated group filer level will simplify compliance and administration consistent with one of the overall objectives of the Act, as opposed to calculating the tax on a single company basis, without creating opportunities for avoidance.

Other provisions in the Code apply a similar approach and rely on the consolidated group to compute liabilities and provide thresholds for tax compliance. For example, section 965 provides that “all of the members of a consolidated group that are United States shareholders of one or more specified foreign corporations will be treated as a single United States shareholder” by reference to the consolidated group definition in Treas. Reg. § 1.1502-1(h) to determine the aggregate foreign cash position and resulting liability thereunder. Most recently, Notice 2018-28 provides that “the amount allowed as a deduction for business interest applies at the level of the consolidated group (as defined in Treas. Reg. § 1.1502-1(h)).” Due to the interplay between sections 163(j) and 59A, the two sections should operate similarly with respect to consolidated group tax treatment as opposed to having one computation performed on a separate company basis and another computation on a consolidated group basis, which would add unnecessary complexity. Therefore, OFII recommends that guidance provide that the BEAT liability be determined at the consolidated group level where related U.S. entities are members of a single consolidated group, as opposed to a separate company basis, for all purposes of section 59A, to ensure an efficient, effective, and administrable approach to BEAT implementation and in a manner consistent with other consolidated group level computations.

In addition, while OFII recommends that computing the BEAT tax liability on a consolidated group basis is sensible in implementing section 59A, we believe that Treasury and the IRS should also apply an aggregated approach where multiple U.S. tax filers exist for purposes of determining the BEAT liability as discussed below.

2. Aggregated Approach to the BEAT Liability

a. Impact of Not Applying an Aggregated Approach to Companies with Multiple U.S. Consolidated Groups

In the case of a company with multiple U.S. consolidated groups,²³ each U.S. consolidated group and foreign members of the controlled group are aggregated to determine if they each satisfy the definition of an applicable taxpayer under section 59A(e) (the “Aggregated Group”). Once the determination is made that each group or separate tax filer (e.g., a foreign corporation that files a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation) meets the applicable taxpayer definition on an Aggregated Group basis, then each group or separate tax return filer would have to compute their BEAT liability based on their own regular tax liability (reduced by certain credits) and MTI. The result of the aggregation rule in section 59A(e) for an inbound company would be that one U.S. consolidated return group could cause another U.S. consolidated return group (or a stand-alone company that is not part of the U.S. consolidated return group) to be subject to BEAT when on a stand-alone basis/single consolidated group basis, one of the filers might not have been an applicable taxpayer.

For example, a U.S. consolidated return group (“US 1”) with a large NOL deduction but a small amount of base erosion tax benefits could be penalized for operating at a loss to the extent a separate U.S. consolidated return group (“US 2”) held by the common foreign parent has a significant amount of base erosion tax benefits and aggregate deductions. US 1 would have to add back a significant amount of its NOL deduction to determine its MTI due to US 2's high base erosion percentage. This leads to a rough result that penalizes the wrong taxpayer. US 1 ends up with an artificially high base erosion percentage as a result of the aggregation rule in section 59A(e). Due to its large NOL deduction, US 1 may have a minimal regular tax liability. However, when the base erosion percentage of the NOL deduction is added back to compute MTI, US 1, who is not making significant Base Erosion Payments but is suffering from an economic loss, is subject to BEAT solely because of US 2's base erosion percentage. This unfortunate outcome (which is more likely to occur when there is a cyclical market, a cyclical industry, or during an economic downturn) may be mitigated if US 1 is able to compute its BEAT liability by aggregating its regular tax liability and MTI with the regular tax liability and MTI of US 2. Allowing US 1 to aggregate with US 2 to determine the BEAT liability of the US1/US2 group creates an appropriate result. This approach would allow taxpayers that are part of an Aggregated Group to take into account their collective regular tax liability to determine whether they pay enough regular tax as a group before being liable for the additional tax imposed under section 59A.

b. Statutory Support for Aggregate Approach

Allowing two or more U.S. consolidated groups that are part of the same Aggregated Group to compute their BEAT liability by aggregating their separate regular tax liability and MTI is consistent with the purpose of the provision, in part, to operate as a minimum tax by looking to whether the Aggregated Group as a whole bears a high enough tax in the United States to not be subject to the minimum tax.²⁴

The aggregation rules clearly apply for purposes of determining an “applicable taxpayer” under section 59A(e)(1) and the taxpayer's “base erosion percentage” for purposes of section 59A(c)(4). However, ambiguity exists as to whether MTI (and, similarly, regular tax liability) is meant to be computed on an aggregated or a separate taxpayer basis under sections 59A(b)(1) and 59A(c). This stems from the references in section 59A(c)(1) to the “taxpayer” as opposed to the “applicable taxpayer.”²⁵ Additionally, the Conference Report to section 59A illustrates that the Congressional intent may have been to also apply the aggregation rule to the computation of MTI. The relevant portion of the Conference Report refers to the applicable taxpayer:

To determine its modified taxable income, the applicable taxpayer computes its taxable income for the year without regard to any base erosion tax benefit of a base erosion payment or base erosion percentage of any allowable net operating loss deduction.²⁶

An Aggregated Group approach can also be supported by the statutory text because 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 stating that it applies for purposes of section 59A(e)(1) and (c)(4). Determining the BEAT liability on an Aggregated Group basis would effectively and efficiently implement the statutory provision.

Additionally, the use of an Aggregated Group approach to computing the BEAT liability would prevent distortions among U.S. consolidated groups and provide one overall liability which may be allocated to the respective entities. The ambiguities in section 59A(e)'s definition of an “applicable taxpayer” and the general grant of authority in section 59A(i), authorize Treasury and the IRS to issue guidance to provide for an Aggregated Group approach in computing the BEAT liability.

c. Applying the Aggregation Rule

OFII recommends that Treasury and the IRS provide guidance to allow taxpayers to compute the BEAT liability on an Aggregated Group basis based on the controlled group definition described in section 59A(e)(3). Under this approach, each member of the controlled group that files a separate return would separately compute its taxable income, NOL deductions, Base Erosion Payments, base erosion tax benefits, regular tax liability and any other items (e.g., credits) that would be relevant for the BEAT liability computation. Following the separate computations, each of the filers would aggregate these amounts to determine the Aggregated Group's MTI and the Aggregated Group's regular tax liability (reduced by certain credits). The BEAT liability could then be allocated to each filer group in proportion to its relevant contribution (i.e., Base Erosion Payments and benefits related to that filer over the amount for the aggregated group) to the group.²⁷

If section 59A is intended to operate as a minimum tax to ensure that taxpayers who are operating in the United States are not overly eroding their base and are paying a sufficient level of tax, then to determine whether sufficient tax is paid, it is reasonable to measure the taxes paid by the Aggregated Group. Accordingly, we recommend that Treasury and the IRS adopt guidance providing that the BEAT liability may be computed on an Aggregated Group basis.

B. Using the Add-Back Method to Determine Modified Taxable Income

MTI means taxable income without regard to any base erosion tax benefit with respect to any Base Erosion Payment, or the base erosion percentage of any NOL deduction allowed under section 172 for the taxable year.²⁸ Clarification is required as to whether the phrase “without regard to” immediately above is intended to require the taxpayer to “add back” their base erosion tax benefits and the base erosion percentage of their NOL deduction to taxable income (the “Add-Back Method”) or, alternatively, to recompute taxable income without base erosion tax benefits or the base erosion percentage of their NOL deduction (the “Recomputation Method”).

A straightforward reading of the statute supports the use of the Add-Back Method. The Add-Back Method is not novel and Treasury and the IRS have used the method in other contexts such as section 163(j) (computing adjusted taxable income) and computing the dividends received deductions under section 243(a). Under this method, taxable income is computed by adding back the enumerated items to such amount.

In addition, the Add-Back Method computes MTI in a simple and administrable manner. This method would not require each taxpayer to recompute its taxable income, allow it to take as a deduction a larger amount of NOL carryforward for the year than it is actually allowed to utilize when computing its taxable income, or require it to keep track of separate tax attributes for purposes of computing regular tax liability and MTI under the BEAT. It also would not require separate elections for regular tax and the BEAT, such as full expensing, or redeterminations of deductions limited by taxable income for foreign derived intangible income or global intangible low taxed income based on MTI under the BEAT.

To illustrate the Add-Back Method, assume in 2018 a calendar year U.S. corporation, US Co., generates $600 million of gross income, makes deductible Base Erosion Payments to foreign related parties (such as royalties and interest) of $550 million, and deductible non-related party payments of $100 million, thereby generating an NOL of $50 million and, based on 2018 deductions, a base erosion percentage of 85 percent. Further, assume that in 2019 US Co. generates $600 million of gross income, makes deductible non-related party payments of $500 million, and deductible Base Erosion Payments of $50 million, thereby generating $50 million of taxable income and, based on 2019 deductions, a base erosion percentage of 9 percent. In 2019, US Co., therefore, utilizes $40 million (equal to 80 percent of $50 million taxable income) of the 2018 NOL carried forward under the new law to reduce its taxable income to $10 million. If the BEAT NOL add-back is based on the base erosion percentage for the 2019 tax year, then US Co. would add-back $3.6 million (equal to $40 million multiplied by 9 percent) to MTI in 2019. However, if the BEAT NOL add-back is based on the base erosion percentage for the 2018 tax year, then US Co. would be subject to $34 million of BEAT.²⁹

In contrast, using the Recomputation Method would require the creation of a rule limiting the amount of NOL deductions “allowed under section 172” that can be used for purposes of computing MTI in order to avoid distortions. Should this approach be adopted without such a rule, then a greater amount of NOL utilization may be available when computing MTI. In this case, if in the example above the Recomputation Method applied the taxable income of the taxpayer would be $100 million ($600 million gross income less $500 million non-related party deductible payments equals $100 million taxable income) and the amount of the 2018 NOL carryforward that may be utilized as an NOL deduction would be $80 million ($80 million equals $100 million multiplied by 80 percent). Under this approach, the NOL deduction would be much larger than it otherwise would have been allowed to reduce its regular tax liability. This would require taxpayers to track, separately, attributes utilized for the computation of regular tax liability and for the computation of MTI under the BEAT. While the TCJA amended section 172, it did not provide for a mechanism to require multiple calculations of NOLs or other tax attributes. Moreover, the legislative history is silent on this point. Such a rule would add complexities on audit and would place an additional burden on the taxpayer and IRS to track these tax attributes.

C. Payments Between Members of an Aggregated Group Should Be Disregarded

As discussed above, the definition of an applicable taxpayer applies an aggregation approach such that all persons treated as a single employer under section 52(a) (i.e., generally a controlled group within the meaning of section 1563 except that more than 50 percent is applied in lieu of 80 percent, and the exception for foreign corporations is disregarded) are treated as a single person.

Guidance should clarify that payments between U.S. or foreign members of the Aggregated Group are disregarded for purposes of computing both the gross receipts and the base erosion percentage. Accordingly, payments between U.S. and foreign corporations held by a common foreign parent would be disregarded. Similarly, payments from a U.S. corporation to a foreign corporation that is engaged in a U.S. trade or business either directly or through a U.S. branch and that is a member of the same controlled group as the U.S. corporation should be disregarded. That being said, we understand that one concern about the statutory text is that if all members, foreign and U.S., of the single employer group are treated as a single person under section 52(a), then the Base Erosion Payments to foreign members may also be disregarded.³⁰ Accordingly, the scope of guidance on this point would have to be appropriately tailored.

Disregarding payments between members of the Aggregated Group for purposes of the gross receipts test and the base erosion percentage is consistent with section 59A(e)(3), which by reason of section 52 and section 1563 treats all members of a controlled group as a single taxpayer. This approach avoids double counting for purposes of the gross receipts tests with respect to payments made to related parties with common ownership over 50 percent. We note that Base Erosion Payments made to a foreign related party with between 25 and 50 percent ownership or one which is a controlled party within meaning of 482 (with less than 50 percent ownership) would still be subject to section 59A.

D. Payments Which Should Be Excluded from BEAT

1. Payments to U.S. Branches of a Foreign Corporation That Have Effectively Connected Income

Section 59A does not specifically exclude a payment to a U.S. branch of a foreign corporation from being treated as a Base Erosion Payment even though the recipient of the payment for U.S. tax purposes (i.e., the foreign corporation) may otherwise be subject to U.S. taxation on its branch activities. Including these payments in the scope of BEAT goes beyond the underlying purpose of preventing base erosion and inappropriately subjects such income to double U.S. taxation.

Treasury and the IRS should provide guidance excluding payments made to U.S. branches of foreign corporations that are effectively connected with the foreign corporation's U.S. trade or business from the definition of Base Erosion Payment. These payments are subject to net basis U.S. federal income tax as effectively connected income under section 882 and a branch profits tax under section 884.

Foreign corporations that are subject to U.S. federal income tax on a net basis should not be treated as receiving a Base Erosion Payment since the policy concern that led to the enactment of section 59A simply does not exist (i.e., a U.S. corporation eroding its U.S. tax base by making payments that are subject to little or no U.S. federal income tax). In addition, if the foreign corporation makes deductible payments to foreign related parties and such deductions are applied to reduce the foreign corporation's effectively connected income, such payments may be treated as Base Erosion Payments and subject to section 59A as an add-back to MTI of the foreign corporation. Therefore, the potential application of section 59A to impose additional tax on the foreign corporation is not eliminated simply by treating payments that are received by the U.S. branch of a foreign corporation as not Base Erosion Payments.

To exclude payments to a U.S. branch of a foreign corporation, guidance could define a U.S. branch of a foreign corporation as a U.S. person (rather than a foreign person) for purposes of section 59A. Treating a U.S. branch of a foreign corporation as a U.S. person is consistent with other provisions (e.g., Treas. Reg. § 1.1441-1(b)(2)(iv)). The section 1441 regulation allows a U.S. branch to agree to be treated as a U.S. person for withholding purposes and to be treated as a withholding agent.³¹ Similarly, regulations under section 6038A treat U.S. branches of foreign corporations as U.S. corporations for reporting purposes. The regulations provide that “a domestic business entity that is wholly owned by one foreign person and that is otherwise classified under Treas. Reg. § 301.7701–3(b)(1)(ii) of this chapter as disregarded as an entity separate from its owner is treated as an entity separate from its owner and classified as a domestic corporation (i.e., a U.S. person) for purposes of section 6038A.”³² Guidance under section 59A could similarly provide that a payment to a U.S. branch of a foreign corporation that is engaged in a U.S. trade or business shall be treated as a payment to a U.S. person and not treated as a Base Erosion Payment.

Additionally, guidance should clarify that payments made between domestic branches of a foreign corporation are not base eroding payments as there are no foreign related party payments. Thus, any deductions allowed in determining taxable income pursuant to Treas. Reg. § 1.861-8 should not be treated as Base Erosion Payments unless they relate to deductions that involve Base Erosion Payments made to other foreign related entities (and not between branches of the foreign corporation).³³

2. Payments to a CFC

Payments that are made to a controlled foreign corporation (“CFC”) that are includible by a U.S. shareholder for purposes of section 951(a) (subpart F income) or section 951A (Global Intangible Low Taxed Income or “GILTI”) should not be treated as Base Erosion Payments since the payments are 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 BEAT. Furthermore, U.S. shareholders that are also treated as an applicable taxpayer would, in computing MTI, need to take into account their subpart F and GILTI inclusions (that is, part of taxable income) which would increase their 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 tax liability on the income under either the subpart F or GILTI regime and also have to include such amounts in computing the U.S. shareholders BEAT exposure.

Accordingly, guidance is requested that excludes a deductible payment to a CFC from being a Base Erosion Payment to the extent such amount is includible in income of a U.S. shareholder of the CFC under section 951(a) or 951A since the payment should not raise any policy concerns and would mitigate the harsh impact of BEAT for applicable taxpayers that are not otherwise eroding the U.S. base with regards to these payments.

3. Payments Pursuant to a Bilateral APA

Additionally, guidance should provide an exclusion for deductible payments made by an applicable taxpayer that are paid in accordance with a bilateral advance pricing agreement (“APA”) from being treated as a base erosion tax benefit, as these amounts have been negotiated by the relevant competent authorities and represent an appropriate arm's length allocation among related parties consistent with an applicable U.S. tax treaty obligation. Further, excluding the deductible payment from being a base erosion tax benefit is consistent with the object and purpose of an applicable U.S. tax treaty, in part, to mitigate against instances of inappropriate double taxation. Bilateral APAs are important tools for both the IRS and multinational enterprises to minimize disputes among treaty partners and provide certainty for global companies engaging in cross-border commerce. Accordingly, we believe that guidance should provide that a transaction agreed to pursuant to a bilateral APA should not be considered as providing a base erosion tax benefit within the meaning of section 59A(c)(2) since these transactions should not be viewed as eroding the U.S. tax base and would be consistent with U.S. treaties. Without this relief, there may be instances of double or multiple taxation as a result of the BEAT.

E. Applying BEAT to Partnerships

1. Base Erosion Payments Made to and from a Partnership

As currently drafted, section 59A is silent regarding its application to partnerships. Guidance is needed to clarify whether a U.S. or foreign partnership should be treated as an aggregate or an entity for purposes of determining whether payments made to and by a partnership are Base Erosion Payments. The provisions of subchapter K of the Code represent two different views regarding the nature of a partnership. Under the “aggregate” view, the partnership is treated as an aggregation of taxpayers, each of whom own an undivided interest in the partnership.³⁴ This view generally prevails when determining the taxation of partnership income as well as the treatment of contributions to and distributions from the partnership.³⁵ The “entity” view, on the other hand, treats a partnership as a separate entity that has a tax existence separate from its partners.³⁶ This view generally prevails in determining the tax consequences of a transfer of a partnership interest.

OFII believes that the aggregate view of a partnership is the approach most consistent with both the purposes of section 59A and the principles of subchapter K. For example, 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. If the payment was made to a U.S. or foreign partnership with foreign partners, such payment would be treated as a Base Erosion Payment. However, to the extent a foreign partner's distributive share of the income is subject to U.S. federal income tax under either section 881 or 882, then such payment should not be a base erosion tax benefit. The adoption of an aggregate approach to a partnership and making determinations at the partner level is appropriate to carry out the purpose of section 59A and would prevent taxpayers from using a partnership to easily circumvent the application of the new provision.

2. Gross receipts

A partnership is not an applicable taxpayer. However, guidance is needed in order to clarify whether or not the gross receipts of a partnership, of which a corporation is a partner, impact the determination of such corporate partner's status as an applicable taxpayer. If gross receipts of a partnership will have an impact on this determination, the guidance should also clarify how and to what extent each corporate partner takes into account their share of the gross receipts.

One approach is that a corporate partner would only take into account items of income reported on a Form K-1 issued to such partner. This would not be a gross receipts concept, but would be consistent with the idea that gross receipts includes investment income (or income from a partnership interest). Another approach is to compute gross receipts at the partnership level and then to allocate a portion of that amount to each corporate partner based on the partner's interest in the partnership (or based on each partner's distributive share of the gross income of the partnership). If an approach similar to the latter approach is adopted, guidance should provide that only gross receipts of a partnership used in computing “effectively connected taxable income” would be attributable to a foreign partner based on such partner's interest in the partnership (or the partner's distributive share of the gross income of the partnership).

While there may be different ways to address this issue, we recommend that Treasury and the IRS issue guidance that for purposes of computing the gross receipts of a corporate partner in a partnership the partner only needs to take into account items of income from the partnership that are reported on Form K-1. This is the most administrable approach for corporate partners and no special rules would be necessary on how to compute and allocate gross receipts for purposes of the BEAT provision.

IV. Conclusion

We believe the suggested guidance discussed above will provide much needed clarity to section 59A while fulfilling the purpose and intent of the provision. 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

cc:
Marjorie Rollinson
Kevin Nichols
Daniel Winnick
Peter Merkel
Anthony Marra