IT Council Seeks Changes to, Raises Concerns With New BEAT Regs

February 4, 2020

CC:PA:LPD:PR (REG-112607-19)
Room 5203
Internal Revenue Service
P.O. Box 7F04
Ben Franklin Station
Washington, D.C. 20044

Dear Commissioner Rettig:

We appreciate the opportunity to comment on proposed regulations REG-112F07-19, “Additional Rules Regarding Base Erosion and Anti-Abuse Tax,” which provide additional guidance as to the calculation and application of the Base Erosion and Anti-Abuse Tax (BEAT).

ITI represents the high-tech community, advocating for policies that advance U.S. leadership in technology, promote innovation, open access to new and emerging markets, protect and enhance consumer choice, and foster increased global competition. Our members are 71 high-tech and tech-enabled companies, including wireless and wireline network equipment providers, computer hardware and software companies, Internet and digital service providers, mobile computing and communications device manufacturers, consumer electronics companies, and network security providers. Our members' investments have not only propelled economic growth and innovation across our country, but have also launched new global industries.

We would like to note upfront that we applaud and greatly appreciate that these proposed regulations include the option for companies to exclude deductions from being considered “base erosion tax benefits” for purposes of BEAT liability by waiving those deductions for all U.S. tax purposes. This was an adjustment ITI had requested in its comments on the first rulemaking implementing the BEAT last year, and it is exceptionally helpful in providing taxpayers with flexibility to manage timing differences.

We also welcome softening of the position imposing BEAT on amortization of assets acquired in nonrecognition transactions. That said, we were disappointed by the anti-abuse rule that accompanied this change of position on nonrecognition transactions in the final regulations issued alongside these proposed rules. We continue to believe that issuance of a corporation's own stock in the context of a nonrecognition transaction should not be treated as a “payment” because it is not economically meaningful. However, at a minimum, we believe this anti-abuse rule represents a taxpayer-unfriendly change that should have been proposed to allow taxpayers to respond, rather than first issued in final regulations.

With respect to the proposed regulations, we respectfully ask that Treasury consider the following revisions to improve the regulations and promote better administrability.

Aligning Close of Year-End for BEAT Purposes

Prop. Reg. §1.59A-2(c)(2)(ii) provides that the change of ownership of a member of an aggregate group (such as the sale of the member to a third party) may result in such member joining or leaving the aggregate group of the taxpayer. As such, a change in ownership of an aggregate group member (either joining or leaving the aggregate group) may trigger a close of that member's tax year. Prop. Reg. §1.59A-2(f)(2), Example 2, describes a transaction occurring at noon on June 30. The analysis of the Example states that the taxpayer's close of the taxable year for BEAT purposes occurs just before noon, the time of the transaction, rather than the end of day. However, other Code provisions governing this transaction for other purposes require the change of tax year to occur as of the end of the day. For example, under §3H1 an acquiring corporation succeeds to and takes into account certain attributes as of the close of the day, not the time of the transaction.

Any such close of tax year for BEAT purposes should align with the close of tax year applied under other provisions of the Code. Specifically, any close of a year-end due for BEAT purposes should be effective as of the end of a day, not the middle of a day. Having a mid-day end of tax-year solely for BEAT purposes when other Code provisions governing the same transaction apply an end-of-day rule for all other purposes would cause unnecessary and substantial administrative burdens, and there appears to be no policy reason for such additional administrative burden. We anticipate that existing Treas. Reg. §1.1502-7F(b)(1)(ii)(A), the current “End of Day Rule,” would be sufficient to establish closing of the tax year for BEAT purposes.

Determination of Allowed Deductions

Prop. Reg. §1.59A-3(c)(5) provides that, solely for purposes of determining the base erosion benefit under §1.59A-3(c)(1), all deductions that could be properly claimed by a taxpayer for the taxable year are determined after giving effect to the taxpayer's permissible method of accounting and to any elections.

We agree that the determination of allowed deductions for purposes of BEAT and any deductions impacted by the election to waive of allowable expenses under §1.59A-3(c)(F) should be determined after giving effect to the taxpayer's permissible method of accounting and to any elections. Such approach appears to greatly simplify the taxpayer's compliance and administration of the election to waive deductions compared to alternative approaches.

Request for Automatic Relief on 2018 Returns in Order to Elect to Waive Expenses on a 201-Amended Return

As mentioned above, Prop. Reg. §1.59A-3(c)(F) provides for an election to exclude deductions from calculation of BEAT liability by waiving said deductions for all U.S. tax purposes, but that election was not available when calendar-year taxpayers completed and filed their 201H corporate tax returns. Therefore, taxpayers may have taken positions on their returns, such as electing to forego bonus depreciation under §1FH(k) or to capitalize R&E expenses under §59(e)(4), that would not have been taken if the election to waive expenses had been available.

The IRS has already provided certain relief related to the bonus depreciation election under Rev. Proc. 2019-33. We request that the relief in Rev. Proc. 2019-33 be expanded so taxpayers may make an automatic change in accounting method election related to their 201H filed return to claim bonus depreciation and change the amount of capitalized R&E on an amended return. If such automatic relief is not provided, taxpayers would be required to request relief through a PLR, which is time consuming and costly for both the IRS and taxpayers. Accordingly, providing automatic relief would benefit both taxpayers and the government.

Amending to Reduce Amount of Deductions Waived

Prop. Reg. §1.59A-3(c)(F)(iii) provides that a taxpayer may make an election to waive deductions on its original filed Federal income tax return and, in addition, a taxpayer may elect to waive, or increase the amount of deductions waived, on an amended Federal income tax return or during the course of an examination of the taxpayer's income tax return for the relevant tax year. However, a taxpayer may not decrease the amount of deductions waived by the election, or otherwise revoke the election on any amended Federal income tax return or during the course of an examination.

Because taxpayers would be allowed to make an election to waive deductions on either an original filed return, an amended return, or while under examination, we do not see a policy reason why taxpayers should be prevented from reducing the amount of deductions waived or revoking the election entirely on an amended return or during the course of an audit. Taxpayers should be allowed to elect out of the waiver election under the same conditions as they are permitted to elect into it.

Application of QDP Rules to Partnership Anti-Abuse Rule

Prop. Reg. §1.59A-9(b)(5) provides an anti-abuse rule for transactions involving the acquisition of a derivative on a partnership interest or partnership assets. Section 59A(h)(1) provides that any qualified derivative payment (“QDP”) shall not be treated as a “base erosion payment.”

We request clarity that the anti-abuse rule in Prop. Reg. §1.59A-9(b)(5) (transactions involving derivatives on a partnership interest or partnership assets) would not apply if the derivatives are qualified derivative payments (“QDPs”) as defined in §59A(h)(1).

Clarity on Incorrect Reference

The last sentence of Prop. Reg. §1.F031(a)-1(b)(7) states that “This paragraph does not apply to any partner described in §1.59A-7(b)(4).” However, it does not appear that §1.59A-7(b)(4) exists, either in the proposed or final regulations.

We request clarification as to which partners Prop. Reg. §1.F031(a)-1(b)(7) does not apply to.

Additional Feedback

Additionally, we would like to express several general observations and concerns that interplay between the BEAT regulations and other regulations will create unduly harsh results, particularly as it impacts cost-sharing agreements for R&D, and distribution of copyrighted articles — of particular interest to us, software. We hope that these observations can be considered broadly as Treasury and the IRS continue their work to finalize the regulations implementing the BEAT.

First, where a cost-sharing agreement is used, a U.S. company paying foreign research services providers and receiving appropriate reimbursement from the foreign participant could trigger BEAT liability, which we believe is an unduly harsh result given that these arrangements do not serve to erode the U.S. tax base.

Under a cost-sharing agreement, while the U.S. and foreign participants each pay their share of R&D costs at the end of the year, the mechanics of who initially pays the foreign services providers can create different results under the BEAT. In most cases, the U.S. company is the supervising party, and this is the most desirable way to structure these transactions due to non-tax-related business considerations such as efforts by some foreign jurisdictions to assert local ownership over the intellectual property resulting from the R&D.

In these cases, the U.S. entity will end up bearing its fair share of the group's R&D expense, which does not erode the U.S. tax base because the exploitation of the IP will, in almost all cases, bring income into the U.S. and increase the U.S. tax base. The expenditure for R&D services provided by an affiliate results in income being retained in the U.S., as it enables the U.S. taxpayer to exploit its IP versus transferring IP ownership to the foreign entity performing the research and development activity.

However, payments to foreign research services providers pursuant to a cost-sharing agreement that are reimbursed by the foreign participant could be considered “base erosion payments” for purposes of determining BEAT liability. We believe that this is an unfair outcome because there is no base erosion and the precise structure of these agreements is driven by non-tax considerations.

Second, we believe that the BEAT rules create concerns related to distribution of software products, producing unduly harsh results. Many U.S.-based multinationals seek to make strategic acquisitions from time to time to supplement their internal R&D efforts and be early market entrants in key niche markets, typically after global searches for ideal potential targets. If a target is foreign, it can create a dilemma under the BEAT regulations as they currently exist.

There are several options for structuring and ownership of IP in the context of a strategic acquisition: the company can purchase the regional or global IP rights into the United States, the United States can serve as a distributor for the U.S. market (and possibly the rest of the North American market), or the acquired foreign entity can sell into the United States. For companies that use cost-sharing agreements, it is not practical to leave the IP ownership and exploitation in the acquired foreign company — doing so creates permanent establishment and other tax concerns (to include being subject to potential withholding taxes, etc.); commercial concerns such as U.S. buyers preferring to buy from U.S. companies as opposed to foreign corporations; foreign currency issues; ease of payment issues; and the like.

However, purchasing the IP rights into the United States or using the U.S. entity as the distributor for the North American market — both desirable outcomes for the U.S. tax base from a policy perspective — create concerns under the BEAT regulations. If the U.S. entity purchases the IP rights, the amortization is considered a base erosion payment for BEAT purposes. If the U.S. entity distributes a copyrighted article, such as software, for the U.S. or North American markets, the regulations treat the income as income from services, so the cost of the acquisition of the copyrighted article is also a base erosion payment, despite the fact that the U.S. entity is earning income from the transaction as opposed to eroding the U.S. tax base. This is also the case if the product is incorporated into a cloud or Software as a Service (SaaS) offering.

Conversely, if the IP was being incorporated into a tangible product, the COGS exception would allow for the U.S. parent to enter into a distribution arrangement without creating potential BEAT liability. Indeed, some interpretations have suggested that if software being distributed is stored on a tangible medium when it is acquired, that produces a different result for purposes of these regulations that would allow for the COGS exception to apply. This type of technical distinction is outdated and is not meaningful from a policy perspective, given that it has no bearing on base erosion. We would urge that it not be a deciding factor in how a payment is treated. We recommend permitting the cost of a copyrighted article being distributed or incorporated into a cloud or SaaS offering to enjoy the COGS characterization.

Once again, we appreciate the opportunity to comment on these regulations, and are more than happy to discuss our input further.

Sincerely,

Sarah Shive
Senior Director and Counsel, Government Affairs
ITI
Washington, DC