Foreign Firm Seeks Clarity on Treatment of U.S. Branches Under BEAT

29 May 2018

Mr. David J. Kautter
Assistant Secretary for Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW, Room 3120
Washington, DC 20220

Mr. Lafayette G. Harter
Deputy Assistant Secretary for International Tax Affairs
U.S. Treasury Department
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Mr. Douglas L. Poms
International Tax Counsel, Office of Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW, Room 3058
Washington, DC 20220

Ms. Marjorie Rollinson
Associate Chief Counsel International
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on the Base Erosion and Anti-Abuse Tax, Internal Revenue Code Section 59A

Dear Mr. Kautter, Mr. Harter, Mr. Poms, Ms. Rollinson:

We would like to share with you our comments concerning the newly enacted Base Erosion and Anti-Abuse Tax (the “BEAT”), Internal Revenue Code (“IRC”) Section¹ 59A, prepared on behalf of Tokio Millennium Re AG (“TMR”), a foreign-based company with a presence in the United States and a material² footprint in the U.S. reinsurance market.³ The comments below are not industry-specific. Rather, these comments are intended to highlight what we believe may be unintended consequences of the BEAT, which would potentially apply broadly to all industries in circumstances where a non-U.S corporation has chosen to operate in the U.S. through a branch office in lieu of a U.S. subsidiary corporation. The statutory discrepancies, which we wish to bring to your attention, affect a broad population of taxpayers across various industries and therefore would not have a unique voice specific to a single industry. From this standpoint, the comments articulated below should not be viewed as advocating on behalf of any particular industry interests but should instead facilitate objective consideration in order to resolve the inadvertent application of the BEAT to U.S. branches. Towards the end of our letter, we have identified certain other issues, which we believe should also be considered in connection with the promulgation of regulations and administrative guidance under Section 59A.

INTRODUCTION

We kindly request that greater clarity be provided concerning whether a U.S. branch office of a non-U.S. corporation engaged in a U.S. trade or business (as a U.S. tax⁴ filer) should be consistently treated under the BEAT as a U.S. taxpayer (whose receipt of payments from U.S. affiliates should not be treated as base erosion payments⁵) or instead as the proxy of a foreign person (whose receipt of payments from U.S. affiliates may be treated as base erosion payments and, even-handedly, whose payments to non-U.S. affiliates should not be treated as base erosion payments).

We believe that the specific fact pattern involving a U.S. branch of a non-U.S. corporation is a unique circumstance that is unlike the general circumstances to which the BEAT would more commonly apply (i.e., payments between two corporations which are not connected with or attributable to a branch office). Rules concerning the U.S. income taxation of U.S. branches are specially crafted to address the unique treatment of U.S. branches from a tax perspective.⁶ In recognition of the longstanding and distinct treatment of U.S. branch offices under Subchapter N of the Code, it is similarly appropriate that the BEAT provisions be clarified in order to suitably characterize a U.S. branch as a U.S. taxpayer and to harmonize the treatment of U.S. branches under IRC 59A with the objective of the BEAT to protect the U.S corporate tax base from erosion. It is our strong belief that such an objective consideration is vital in order to ensure a level playing field among market participants, and to avoid distortionary outcomes for a select population of U.S. taxpayers without any otherwise rational justification for what would invariably amount to their disparate and unfair treatment. Guidance in this area to resolve any ambiguity concerning the treatment of a U.S. branch office under the BEAT would afford greater legal certainty for multinational corporate groups.

BACKGROUND TO THE BASE EROSION AND ANTI-ABUSE TAX

As is readily apparent from the name of the provision, the BEAT seeks to negate the erosion of the U.S. tax base by ferreting out base erosion payments, which produce a “base erosion tax benefit.”⁷ Originally authored by the U.S Senate Finance Committee, the conference committee at reconciliation agreed to follow the Senate amendment while making a number of changes to the statutory text as drafted by the Senate.⁸ Elucidating the intent of the Senate Finance Committee in crafting the BEAT, the Chairman's Mark, Section-by-Section Summary, as published on November 16, 2017, explained that,

[c]urrently, foreign-owned U.S. subsidiaries are able to reduce their U.S. tax liability by making deductible payments to a foreign parent (or foreign affiliates). This often results in earnings stripping when deductible related-party payments are subject to little or no U.S. withholding tax. Foreign parents take advantage of these deductions through the use of interest, royalties, management fees, or reinsurance payments from the U.S. subsidiary.⁹

Consistent with its intentions to curb payments which erode the U.S. tax base, the Senate Finance Committee on or about November 29, 2017, published its Explanation of the FY 2018 Reconciliation tax legislation (the “SFC Explanation”), and provided further explanation for its rationale in conceiving new Section 59A, “Tax on base erosion payments of taxpayers with substantial gross receipts (sec. 14401 of the bill . . . and new secs. 59A and 59B of the Code).” Lodged within Part II — Inbound Transactions of Section D. International Tax Provisions, the Senate Finance Committee reaffirmed its purpose for new Section 59A to tax certain payments, which “can erode the U.S. tax base if the payments are subject to little or no U.S. withholding tax . . . This type of base erosion has corroded taxpayer confidence in the U.S. tax system.”¹⁰

The objective of the provision is accomplished by imposing U.S. taxation on payments departing from the U.S. tax net which would otherwise reduce U.S. corporate tax liability:

To the extent that corporations with significant gross receipts are able to utilize deductible related party payments to foreign affiliates to reduce their U.S. corporate tax liability below 10-percent, the Committee intends that the base erosion and anti-abuse tax function as a minimum tax to preclude such companies from significantly reducing their corporate tax liability by virtue of these payments.¹¹

The phraseology used by the Senate Finance Committee makes plain its intent for the BEAT to function as a minimum tax but only, “To the extent that corporations . . . are able to utilize deductible related party payments to foreign affiliates to reduce their U.S. corporate tax liability below 10-percent.”¹² This diction unequivocally demonstrates the purpose of the provision to apply only to payments which in fact reduce the U.S. corporate tax liability of U.S. taxpayers (according to the prescribed aggregation rules¹³). Efforts to combat payments which reduce or erode the U.S. corporate tax base were actualized through the adoption of a broad definition of a base erosion payment: “The term 'base erosion payment' means any amount paid or accrued by the taxpayer to a foreign person which is a related party of the taxpayer and with respect to which a deduction is allowable under this chapter.”¹⁴

The ethos of the BEAT, to implicate a deductible outbound payment made by a U.S. taxpayer to a foreign affiliate only to the extent the U.S. tax base is eroded, is consistent with the view expressed in the SFC Explanation, reiterated by the Chairman's Mark, Section-by-Section Summary: “This can erode the U.S. tax base if the payments are subject to little or no U.S. withholding tax."¹⁵ Subparagraph (c)(1)(B) of IRC 59A embraces this notion that the U.S. tax base is not eroded by a deductible outbound payment made to a foreign affiliate to the extent that U.S. withholding tax is applicable to such payment:

(B) Tax Benefits Disregarded if Tax Withheld on Base Erosion Payment. — (i) In General — Except as provided in clause (ii), any base erosion tax benefit attributable to any base erosion payment — (I) on which tax is imposed by section 871 or 881, and (II) with respect to which tax has been deducted and withheld under section 1441 or 1442, shall not be taken into account in computing modified taxable income under paragraph (1)(A) or the base erosion percentage under paragraph (4).

UNINTENDED CONSEQUENCES FOR U.S. BRANCHES OF FOREIGN CORPORATIONS

a. The BEAT was Intended to Police Certain Cross-Border Payments, not a Wholly U.S. Domestic Transaction on which the Recipient is Subject to U.S. Income Taxation

The definition of a “base erosion payment”¹⁶ — any amount paid or accrued by the taxpayer to a foreign person which is a related party — would appear to fail its specified purpose of applying only to the extent that corporations reduce their U.S. corporate tax liability if such definition were read to broadly apply to payments received by a U.S. branch office of a non-U.S. corporation. A U.S. branch office of a non-U.S. corporation operating a trade or business within the U.S. will generally be a U.S. taxpayer (by virtue of its domestic activities) and would pay U.S. income tax on such receipts.¹⁷ In this instance, because the U.S. branch is not a regarded person for U.S. tax purposes, the receipts of the U.S. branch are technically received by a foreign person as described in IRC 59A(d)(1) (i.e., the non-U.S. corporation, operating the U.S. branch, is not a United States person under IRC 7701(a)(30) as referenced by IRC 6038A(c)(3)). Notwithstanding the intent for the BEAT to protect the U.S. tax base by neutralizing related-party deductible payments which would significantly reduce the U.S. corporate tax liability of U.S. taxpayers, the legislative text ostensibly overlooks the circumstance, not completely uncommon among U.S. inbound companies, pursuant to which a non-U.S. corporation derives the payment in connection with its operation of a U.S. business through a U.S. office (or such U.S. business is operated through a wholly-owned unincorporated entity classified as an entity disregarded as separate from its owner for tax purposes¹⁸). In such case, the non-U.S. corporation's U.S. branch includes the receipt of such payment in U.S. gross income. The receipt of such payment by the U.S. branch office (or by a legal entity which is classified as an entity disregarded as separate from its owner¹⁹) would not reduce U.S. corporate tax liability because the U.S. branch office would file a U.S. income tax return,²⁰ and would pay U.S. income tax on its net income (inclusive of the payment received from a U.S. affiliate).²¹ Indeed, the very mechanics of IRC 882 are such that such a taxpayer is rendered identical to a U.S. person for these purposes, being subject to tax under the same provisions (IRC 11) that would apply to a U.S. corporation.²² Lodged within the International Tax Provisions section of the Joint Explanatory Statement of the Committee of Conference²³, the BEAT was clearly conceived to scrutinize cross-border payments as a mechanism to combat earnings stripping, not to discourage wholly domestic transactions within the U.S.²⁴ Upon consideration of the legislative history, there is no indication that the statute sought to implicate wholly U.S. domestic transactions (such as ECI derived by a U.S. branch office; otherwise, if wholly U.S. domestic transactions had been intended to be targeted by the BEAT, one would have expected that payments to U.S. corporations would also have the capacity to be implicated by IRC 59A).

Additionally, imposing base erosion minimum taxation on the receipts of a U.S. branch would be at odds with the purpose of the statute to exclude payments already subject to U.S. taxation and, therefore, not erosive as demonstrated by IRC 59A(c)(1)(B), which explicitly disregards payments to the extent they are subject to nonresident withholding tax. Based on the foregoing, it would seem irrational to subject a payment which is includible in U.S. gross income to the BEAT, but to exclude from the BEAT a payment which is subject to 30% nonresident withholding tax. Needless to say, the receipt of income by a U.S. branch, which is effectively connected with the conduct of a trade or business within the U.S. (“ECI”) would generally not entail a cross-border transaction at all.

b. Imposition of the BEAT on Receipts of a U.S. Branch would not Protect the U.S. Tax Base from Erosion, but would Discourage Base Enhancement due to Risk of Excessive Taxation

Necessarily, receipt of payments by a U.S. branch would not erode the U.S. corporate tax base where the U.S. branch is subject to net income taxation in the U.S. on such payments. Thus, application of the BEAT in these circumstances would not achieve its purpose of restoring the U.S. tax base. If the BEAT were applicable to a U.S. branch's receipt of a related party payment from a U.S. affiliate, the payment would potentially be subject to addback to modified taxable income of the paying U.S. affiliate while still being includible in U.S. gross income in the hands of the U.S. branch. After consideration of the U.S. branch profits tax,²⁵ it is well within the realm of probability that a single payment received by a non-U.S. corporation's U.S. branch could cumulatively be taxed by the U.S. three times. Nothing in the legislative history of IRC 59A suggests that this inequitable result was intended.

IRRECONCILABLE CONTRADICTIONS OF TREATING A U.S. BRANCH'S RECEIPTS AS BASE EROSION PAYMENTS

Within the context of a U.S. branch office operated by a non-U.S. corporation, application of the definition of a base erosion payment gives rise to an apparent contradiction because such definition may be construed to implicate both the payments made by the U.S. branch to a related non-U.S. person and the payments received by the U.S. branch (from related U.S. persons). A base erosion payment encompasses an amount paid to a related foreign person, “of the taxpayer and with respect to which a deduction is allowable under this chapter.”²⁶ Permitting receipts of a U.S. branch (paid by a U.S. related person) to be treated as a base erosion payment cannot be reconciled with the capacity of the U.S. branch to make base erosion payments. There does not appear to be any justification given for ascribing a dual characterization of a U.S. branch on the one hand as a foreign person for purposes of treating its receipts as base erosion payments, but contrarily casting the U.S. branch as a U.S. taxpayer potentially bearing a base erosion minimum tax liability for purposes of its own payments. Furthermore, there is no legislative history probative of legislative intent to effectuate this dual characterization (or even to have contemplated this result).

Meanwhile, the economic ingredients of a U.S. branch office are in substance equivalent to those of a U.S. subsidiary corporation: a U.S. branch office pays U.S. income tax on its net income (i.e., ECI)²⁷ and files a U.S. income tax return.²⁸ Whereas the receipts of a U.S. subsidiary corporation would not come within the definition of a base erosion payment, treating the receipts of a U.S. branch as base erosion payments creates an unequal playing field in favor of non-U.S. persons operating in the U.S through a U.S. subsidiary corporation. Such treatment disfavors unincorporated businesses without a rational justification for doing so. The SFC Explanation provides that the BEAT was enacted to create a level playing field, not to discriminate against unincorporated businesses in the U.S. that are already subject to U.S. taxation: “This provision aims to level the playing field between U.S. and foreign-owned multinational corporations in an administrable way . . . The Committee believes that this level playing field, along with a globally competitive corporate rate, will encourage economically efficient foreign direct investment.”²⁹

OTHER ISSUES FOR CONSIDERATION UNDER SECTION 59A

The BEAT imposes “on each applicable taxpayer . . . a tax equal to the base erosion minimum tax amount for the taxable year.”³⁰ Read strictly, the statute calls for the calculation of the base erosion minimum tax amount with respect to “any applicable taxpayer,”³¹ by computing “the excess (if any) of — (A) an amount equal to 10 percent . . . of the modified taxable income of such taxpayer . . .”³² In application, the definition prescribed for an applicable taxpayer may in fact include multiple taxpayers, who file separate U.S. tax returns. Aggregation rules require corporations connected through stock ownership of greater than 50% (by vote or value) to be combined and treated as 1 person for purposes of determining the base erosion percentage and the base erosion minimum tax amount.³³ Notably, the applicable taxpayer definition under the BEAT includes foreign corporations.³⁴ In doing so, the BEAT would require a plurality of U.S. taxpayers filing separate U.S. tax returns to comply with the BEAT'S reporting requirements notwithstanding that such U.S. taxpayers would not be permitted to file a U.S. consolidated return. Specifically, while an affiliated group of corporations is permitted to join in filing a consolidated return for U.S. income tax purposes, the definition of an affiliated group for this purpose expressly excludes from the category of an “includible corporation” any foreign corporation and any life insurance company (i.e., an insurance company subject to taxation under Section 801).³⁵ Under circumstances in which computation of the base erosion minimum tax amount must be performed with respect to multiple taxpayers who file separate U.S. tax returns, separate reporting requirements imposed on each separate tax filer may result in administrative hardship.³⁶

TMR, a Swiss-based reinsurance company operating branch offices in the U.S. and in other jurisdictions, is a wholly owned subsidiary of Tokio Marine and Nichido Fire Insurance Co., Ltd (“TMNF”), a company incorporated in Japan. Additionally, TMNF owns (directly or, in several instances, indirectly) the shares of seven separate U.S. tax filers including Delphi Financial Group, Inc. (a U.S. property and casualty insurer and life insurance group focusing on employee benefit products in the U.S), HCC Insurance Holdings, Inc. (a world-leading specialty insurance group), and Tokio Marine North America, Inc. (the U.S. parent of Philadelphia Consolidated Holding Corp., a U.S. property and casualty insurance group)(hereinafter, the seven separate U.S. tax filers collectively referred to as the “U.S. Sister Companies”).

Based on the ownership in each of the U.S. Sister Companies, the absence of a common parent corporation which is an includible corporation (described in IRC 1504(a)) does not permit a U.S. consolidated return to be jointly filed by the U.S. Sister Companies and TMR. Furthermore, TMR (inclusive of its U.S. branch) is a foreign corporation and, therefore, is not an includible corporation eligible to join in filing a U.S. consolidated return. Finally, in light of the diverse lines of insurance business distinctly operated in the U.S. by each of the U.S. Sister Companies, it may be observed that additional hurdles to filing a consolidated return are posed by relevant consolidated return regulations in the context of life-nonlife groups.³⁷

Therefore, we kindly request that guidance be considered for taxpayers filing separate U.S. tax returns (such as in the case where the filing of a consolidated return for U.S. income tax purposes is not permissible) who are required to aggregate solely for purposes of computing the base erosion minimum tax amount and complying with concomitant reporting requirements arising out of the BEAT (including the permissibility of persons to file a joint information return³⁸ to furnish information required under the BEAT where such persons otherwise file separate income tax returns but are treated under IRC 59A(e) as an applicable taxpayer).

RECOMMENDATIONS FOR CONSIDERATION

We have provided the foregoing comments with the hopes that the U.S. Treasury Department provides clarification in forthcoming regulations and other administrative guidance that the BEAT was not intended to apply to a payment which is included in U.S. gross income by a U.S. branch of a non-U.S. corporation (e.g., ECI) because such payment remains within the U.S. tax net and is not erosive of the U.S. tax base. We also hope that due consideration will be given to the other issues we have raised above for which guidance is appropriate.

Thank you for your time in considering these comments. We hope that you will contact us if you have any questions regarding this letter or if you would like to discuss this matter further.

Sincerely,

Jonathan Tiegerman
Vice President, Tax
JTieqerman@tokiomillennium.com
D: +41 43 283 6020

Maurice Kane
Chief Financial Officer
MKane@tokiomillennium.com
D: +41 43 283 6044

Tokio Millenium Re AG
Zurich, Switzerland