Tax Group Cautions Against ‘Waiver Penalty’ in New BEAT Regs

February 4, 2020

CC:PA:LPD:PR (REG-112607-19)
Room 5203
Internal Revenue Service
PO Box 7604
Ben Franklin Station
Washington, DC 20044.

Re: Comments on proposed regulations implementing IRC section 59A (NPRM REG-112607-19)

Dear Sir or Madam:

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

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

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

Yours sincerely,

Alliance for Competitive Taxation

cc:
L. G. “Chip” Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury Department
Doug Poms, International Tax Counsel, U.S. Treasury Department
Azeka J. Abramoff, Attorney-Advisor, ACC(I), Internal Revenue Service
Shelia Ramaswamy, Attorney-Advisor, ACC(I), Internal Revenue Service
Karen Walney, Attorney-Advisor, ACC(I), Internal Revenue Service

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

I. INTRODUCTION

This document sets forth the comments of the Alliance for Competitive Taxation (“ACT”) on the second round of proposed regulations implementing section 59A of the Internal Revenue Code as amended by the Tax Cuts and Jobs Act (NPRM REG-112607-19) (the “Proposed Regulations”).

II. COMMENT RELATING TO CERTAIN ASPECTS OF PROPOSED REGULATIONS

1. Election to Waive Deductions (Prop. Reg. § 1.59A-3(c)(6))

Proposed Regulations and Final Regulations

The Proposed Regulations provide a taxpayer with the election to waive deductions for the purpose of determining the amount of base erosion tax benefits that are taken into account in determining the base erosion percentage of the taxpayer or the taxpayer's aggregate group. Any deduction that is electively waived is treated as having been waived for all purposes of the Code and regulations. Thus, if pursuant to Prop. Reg. §1.59A-3(c)(6), a taxpayer elects to waive a deduction, such deduction may not be used to reduce the regular taxable income of the taxpayer.

Treasury Explanation

The preamble to the Proposed Regulations states that the election to waive deductions was provided in response to taxpayer comments.

ACT Recommendation

ACT recommends, consistent with the statutory construction of section 59A, that a deduction waived under Prop. Reg. § 1.59A-3(c)(6) remain in the denominator of the base erosion percentage fraction.

Reasons for ACT Recommendation

ACT applauds Treasury in providing taxpayers the ability to waive deductions in order to prevent the taxpayer from qualifying as an applicable taxpayer under section 59A(e).

The waiver allows the taxpayer to mitigate the potentially large “cliff effect” that would occur where one dollar of base erosion payment potentially triggers millions of dollars of BEAT liability. However, to avoid the cliff, the taxpayer needs to waive $103.09 ($100/0.97) of deductions for all purposes for every $100 of base eroding payments in excess of three percent of total deductions, because the proposed rule requires that any waiver of deductions of base eroding payments (the numerator of the base erosion percentage) also reduce the denominator of the base erosion percentage. This is tantamount to a 3.09-percent deduction penalty for taxpayers that elect to use the waiver.

ACT believes that its recommendation aligns the mechanics of the waiver with the most natural reading of the statute. The “base erosion percentage” is determined as a fraction with a numerator divided by a denominator. The numerator is defined as “the aggregate amount of base erosion tax benefits of the taxpayer for the taxable year.”¹ The phrase “base erosion tax benefit” is defined as a deduction which “is allowed by this chapter for the taxable year with respect to any base erosion payment.” The denominator of the fraction is the sum of the “ . . . aggregate amount of deductions . . . allowable to the taxpayer”², plus certain base erosion tax benefits related to insurance contracts and expatriated entities. The statute further delineates certain deductions that are not included in the denominator, including:

• “any deduction allowed under section 172, 245A, or 250 for the taxable year,”

• “any deduction for amounts paid or accrued for services to which the exception under subsection (d)(5) applies [relating to the services cost method under section 482], and”

• “any deduction for qualified derivative payments which are not treated as a base erosion payment by reason of subsection (h) [relating to payments made in the ordinary course of trade or business].”³

ACT believes the natural reading of the numerator includes only deductions actually taken into account by the taxpayer (i.e., allowed deductions); and the natural reading of the denominator includes, subject to the statutory exceptions described above, all deductions available to the taxpayer (i.e., allowable deductions) regardless of whether the taxpayer actually claimed the deduction. Thus, to avoid the imposition of an effective waiver penalty (as discussed above), and to adhere most closely to the statutory text of section 59A, ACT recommends that any deduction electively waived continues to be taken into account in the denominator of the base erosion percentage fraction.

Regulatory Authority for Recommendation

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

2. Proposed Additional Effect of Election to Waive Deduction under Prop. Reg. § 1.59A-3(c)(6)(ii)

Proposed Regulations

The Proposed Regulations are silent on whether the election to waive a deduction under Prop. Reg. § 1.59A-3(c)(6) is made at the partnership or partner level when the election relates to a deduction attributable to a partner who receives a schedule K-1 from a partnership.

Treasury Explanation

The Treasury Department and the IRS request comments regarding the election to waive deductions, including the reporting requirements.

ACT Recommendations

ACT recommends that a new clause be added to the regulations to clarify that an election to waive a deduction under Prop. Reg. § 1.59A-3(c)(6) is made at only the partner level for deductions allocated to a partner on schedule K-1:

Reasons for ACT Recommendation

Prop. Reg. § 1.59A-3(c)(6)(i)(A) – (G) provides for detailed disclosure requirements relating to a taxpayer's election to waive a deduction. There is no guidance in the Proposed Regulations that clarifies whether partners who receive a schedule K-1 from a partnership have the ability to waive the deduction at the partner level. The determination of whether the taxpayer elects to waive a deduction is more appropriate at

the partner level because not all partners may be similarly situated. Furthermore, a partnership level election may present issues under partnership governance provisions for making elections (most of which were agreed upon by the partners prior to the regulations). Treasury has previously overridden the general rule under section 703(b) providing for partnership level elections (e.g., Treas. Reg. § 1.871-10(d)(3)). ACT believes that the regulations should provide that the election to waive deductions allocated to a partner on schedule K-1 be made at the partner level in order to avoid conflict among differently situated partners given the taxpayer specific nature of such election.

III. COMMENT RELATING TO CERTAIN ASPECTS OF THE FINAL REGULATIONS

Anti-abuse rule related to specified non-recognition transactions (Treas. Reg. § 1.59A-9(b)(4))

Final Regulations

The Final Regulations generally exclude from the definition of 'base erosion payment amounts' transferred to, or exchanged with, a foreign related party in transactions described in sections 332, 351, 355, or 368 (the “specified non-recognition transaction exception”).⁴

The Final Regulations also add an 'anti-abuse' rule with respect to specified nonrecognition transactions, providing that if a transaction has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in the nonrecognition transaction, then the specified non-recognition transaction exception does not apply (the “Anti-abuse Rule”). Moreover, if a transaction between related parties increases the adjusted basis of property within the six-month period before the taxpayer acquires the property in a specified nonrecognition transaction, the transaction is deemed to have a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a nonrecognition transaction (i.e., taxpayers are not allowed to rebut the presumption that the transaction was undertaken with a principal purpose of increasing the tax basis of the property).

Treasury Explanation

In the preamble to the Final Regulations, Treasury and IRS explain that the Anti-abuse Rule was provided because in certain instances, the exclusion of nonrecognition transactions from the definition of base erosion payment could lead to inappropriate results.

ACT Recommendations

ACT recommends that the Anti-abuse Rule be modified by providing:

Reasons for ACT Recommendation

ACT applauds Treasury in providing the specified non-recognition transaction rule. The rule will increase incentives to move intangible property and other income-producing property into the United States. However, the Anti-abuse Rule, as currently structured, can be read in a way to create a “cliff effect” for transactions with a minimal amount of pre-transaction basis step up, thus denying taxpayers the ability to inbound property to the United States without adverse BEAT implications (i.e., the specified non-recognition transaction exception would not apply).

The strict approach set forth in the Final Regulations creates a trap for unwary taxpayers that believe the specified non-recognition exception applies to a particular transaction. In certain circumstances a taxpayer may not be aware of to an increase in basis until after a specified non-recognition transaction has occurred. ACT recommends that, if an increase in basis that would preclude the taxpayer from qualifying for the specified non-recognition transaction exception is discovered, utilizing the framework of Prop. Reg. § 1.59A-3(c)(6), the taxpayer should be able to forgo the increased basis for all purposes of the Code, including the future disposition of the asset (and thus the transaction would continue to qualify for the specified non-recognition transaction exception). ACT recommends this election be available for taxpayers filing a timely return, an amended return, or during the course of an IRS examination.⁵

In addition, Treasury and the IRS should consider a de minimis rule that would allow taxpayers to engage in ordinary business transactions that have minimal impact to the adjusted basis of property subject to the specified non-recognition transaction exception. For example, if a taxpayer realizes an increase in basis to property that is not material to the amount of property subject to the specified non-recognition transaction exception, such increase in basis cannot conceivably be a result of tax planning. Similar to the de minimis rule provided in section 954(b)(3) (related to subpart F income), if the basis in property is increased by the lesser of 5% of the amount of property subject to the specified non-recognition transaction or $1,000,000, ACT recommends the entire transaction continue to qualify for the specified non-recognition transaction exception.

Regulatory Authority for Recommendation

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

IV. CONCLUSION

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