Pension Investment Board Looks for Exception in BEAT Regs

May 3, 2019

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

Re: Follow-Up Comments on Section 59A

Dear Mr. Poms:

Thank you for meeting with us on March 14, 2019 to discuss our September 4, 2018 letter (the “Prior Letter”) with respect to Treasury regulations to be issued under Section 59A of the Code. Having had the benefit of your thoughts and further opportunity to review the proposed regulations issued following the date of the Prior Letter, we have been able to narrow and clarify the position set out in the Prior Letter.

For the reasons set forth herein, we believe that integral parts and controlled entities of a foreign government, other than controlled commercial entities, as those terms are used in Section 892 of the Code and related Treasury Regulations (“Section 892 Foreign Governments”) should not be treated as a corporation for purposes of the aggregation rule in Section 59A(e)(3), which cross-references the term “controlled group of corporations” as defined in Sections 52(a) and 1563(a). Specifically, we believe that Section 892 Foreign Governments should not be treated as the parent of a parent-subsidiary controlled group as defined in Section 1563(a)(1) or as an owner of a brother-sister controlled group as defined in Section 1563(a)(2), at least for purposes of Section 59A(e)(3).

As a result of not applying Section 1563 to Section 892 Foreign Governments, the base erosion percentages¹ of one portfolio company majority owned by PSP would not be aggregated with those of a sister portfolio company not in the same chain of ownership. However, the aggregation rules would continue to apply to the base erosion percentages of members of a particular portfolio company's separate group as determined under Section 1563. Moreover, Section 59A would continue to apply to payments made by such a portfolio company to a related foreign government shareholder, if that particular portfolio company is, itself, an “applicable taxpayer.” That is because a base erosion payment is one made to any foreign person, not only a foreign corporation. We believe that the position set forth in this letter is fully consistent with the spirit and the statutory language of Section 59A.

The term “foreign government” is not defined in the Code, even in Section 892. The regulations under that Section define the term foreign government as being only the integral parts and controlled entities of a foreign sovereign. Thus, both the undersigned, a Canadian crown corporation established by an act of parliament², and the Treasury Board of Canada, an integral part of the Canadian government that nominally holds 100% of our shares, are foreign governments.

Controlled entities of a foreign government are not eligible to claim Section 892 benefits in a year in which they are engaged in commercial activity. It is the position of the IRS that a controlled entity such as PSPIB that engages in any commercial activity anywhere in the world is a controlled commercial entity and therefore ceases to be a Section 892 Foreign Government. To preserve its status as a Section 892 Foreign Government, a controlled entity such as PSPIB cannot engage into activities going beyond passively investing in portfolio companies. It cannot manage the business of a portfolio company. It cannot, as an operating matter, redeploy cash flow from one portfolio company to another in order to maximize the value of the group as a whole. It cannot provide property or services to its portfolio companies subject to any transfer pricing rules (other than equity and debt capital). As a result, each portfolio company stands on its own without any commercial assistance from the Section 892 Foreign Government that owns its shares.

Given the constraints of Section 892, and for other reasons, a Section 892 Foreign Government is not operated like a large international conglomerate, but rather like a large institutional investor. Foreign government investors, unlike conglomerates, are not answerable to shareholders, who make their individual investment decisions based on the value of the conglomerate as a whole and who seek to profit by receiving dividends and/or by selling stock. A conglomerate is managed from the top down as a single economic enterprise. It therefore makes sense to treat the top holding company of a typical conglomerate as the “parent” for purposes of Section 1563(a)(1). However, we respectfully submit that it does not make sense to treat an investor in the same way, since it cannot exercise operational and management control over its portfolio companies.

PSPIB is, in the sense relevant to the application of Section 59A, typical of a Section 892 Foreign Government investor. PSPIB was established by the Government of Canada for the purposes of managing amounts transferred to it from pension contributions on behalf of Canadian federal employees in the best interests of contributors and beneficiaries, and investing its assets with a view to achieving a maximum rate of return, without undue risk of loss, having regard to the funding, policies and requirements of the relevant pension funds and the ability of those pension funds to meet their financial obligations. Over the years, PSPIB has therefore developed a portfolio strategy that encompasses a specific targeted allocation to different asset classes. As such, PSPIB evaluates each of its investments, within each of the asset classes, having regard to the expected risk-adjusted rates of return of the relevant asset class to which it belongs.

To fulfill its statutory mandate, PSPIB retains a highly-qualified investment team. Members of the team are divided into deal teams that are in turn responsible to invest and manage investments belonging to their own asset classes (e.g., infrastructure, real estate, public markets, private equity). Their compensation is largely influenced by how well their particular asset class performs compared to the market.

To these ends, the current BEAT aggregation rules make it considerably difficult and impractical for investors such as PSPIB and other Section 892 Foreign Governments to price and to hold majority-interests in completely independent and unrelated US investments as they introduce an important element of uncertainty in our portfolio construction and management activities.

There are substantial precedents for treating organizations that do not have private shareholders as other than corporations for purposes of applying the Code's attribution and control tests. For example, charitable organizations exempt from tax under Section 501(a) of the Code are excluded from the aggregation rules of Section 1563 except to the extent they are subject to the unrelated business income tax.³ Not only can a charity not be a common parent of a group, any stock in a subsidiary member held by a charity is not taken into account.⁴ In the same manner, stock held by certain pension trusts is excluded from Section 1563.⁵ Since an incorporated foreign government cannot be engaged in any commercial activity and thus cannot be engaged in a business, it is analogous to a charitable organization not engaged in an unrelated trade or business, and should be treated in the same way for purposes of Section 1563.

In addition, a long line of cases and rulings stand for the proposition that an organization lacking private shareholders should not be treated as an ordinary corporation for purposes of applying constructive ownership rules.⁶ In the words of the Tax Court, a corporation owned by a foreign government is “not a corporation as that term is understood in the United States.”⁷ It is clear that the court came to this conclusion based on the fact that the corporation had been formed for a governmental purpose and had no private shareholders motivated to extract profits via dividends or the sale of stock to a third party for gain.

As a policy matter, treating a foreign government's portfolio companies as having no common parent is consistent with the manner in which a foreign government must own and manage its investments. A foreign government that cannot conduct any business of its own should not be treated as the parent of an affiliated group of corporations that are treated as a single person. The aggregation rules of Sections 52(a) and 1563 operate to treat a group of corporations as a single employer or single person for purposes of those Code sections that refer to them. We do not believe those Sections can properly be interpreted to treat a Section 892 Foreign Government as a single person with corporations formed in a different country. Moreover, one could reasonably assume that Congress did not intend the BEAT to be aimed at Section 892 Foreign Governments since their reality and modus operandi is very different from multinationals⁸.

Although a Section 892 Foreign Government should not be treated as the common parent of a group of corporations for purposes of aggregating the base erosion percentages of all corporations that it controls, there is no reason why Section 59A cannot apply to a base erosion payment made by a U.S. corporation to a foreign government that owns 25% or more of its shares, assuming that the U.S. subsidiary is an “applicable taxpayer.” For purpose of applying the threshold tests of Section 59A(e)(1), we believe that the gross receipts and base erosion percentages of the applicable U.S. subsidiary and any group of which it is a common parent (or any group of which it is a member without regard to the foreign government) should be aggregated.

Request for Relief

We respectfully request that the BEAT final regulations provide an exception to the BEAT aggregation rule in Section 59A(e)(3) and provide that integral parts and controlled entities of a foreign government, other than controlled commercial entities, as those terms are used in Section 892 of the Code and related Treasury Regulations, should not be treated as a corporation for purposes of that rule. Treasury has broad regulatory authority in that respect. Section 59A(i) provides in part that Treasury “shall prescribe such regulations as may be necessary or appropriate to carry out the provisions of this section.”

One possible way to include such an exception in the regulations, when finalized, would be to modify the definition of “aggregate group” in Proposed Treas. Reg. § 1.59A-1(b). For example, it could be modified by adding: “(iii) any person that is an integral part or a controlled entity, other than a controlled commercial entity, of a foreign government under Section 892 is not treated as a corporation for purposes of determining whether a corporation in which such person owns an ownership stake directly or indirectly satisfies the base erosion percentage test.”

Alternatively, consideration could be given to adding the following sentence after the first sentence in current Proposed Treas. Reg. § 1.59A-2(c) (the first sentence currently reads “a taxpayer that is a member of an aggregate group determines its gross receipts and its base erosion percentage on the basis of the aggregate group as of the end of the taxpayer's taxable year.”)

Notwithstanding the above, a person that is an integral part or a controlled entity, other than a controlled commercial entity, of a foreign government under Section 892 is not treated as a corporation for purposes of determining whether a taxpayer in which such person has an ownership interest determines its base erosion percentage on the basis of the aggregate group.

We appreciate the opportunity to provide these follow-up comments on Section 59A. Please do not hesitate to contact us if you have any questions or comments regarding our submission.

Sincerely,

Public Sector Pension Investment Board
By Jean-François Ratté, Vice President and Head of Taxation
PSP
Montreal, Quebec