The Tax Cuts and Jobs Act added a new provision to the Internal Revenue Code called the “Base Erosion and Anti-abuse Tax” (BEAT). The BEAT acts as a minimum tax and applies to large corporations with at least $500 million in gross receipts. The new tax is effective for taxable years beginning after December 31, 2017.
The BEAT does not apply to individuals, S corporations, RICs or REITs. There is also a de minimis exception for companies whose foreign related party payments are low relative to overall deductions.
The BEAT is generally calculated by taking 10 percent of modified taxable income. The rate is 5 percent for years beginning in 2018 to help phase-in the new regime. It increases to 12.5 percent for years beginning after 2025.
Deductible payments to related foreign persons are added back to taxable income to arrive at modified taxable income. There is also an “add back” for depreciation and amortization deductions associated with property acquired from related foreign persons.
A foreign person is considered a “related person” if it owns at least 25 percent of the stock of the taxpayer (by vote or value) or satisfies other control tests.
As the BEAT acts as a minimum tax, this means a taxpayer with $100 of regular taxable income, and regular corporate tax of $21, would be subject to the 10% BEAT tax if deductible payments to foreign affiliates exceed $110. This is because modified taxable income would exceed $210. After applying the 10% BEAT tax, the BEAT tax amount would be greater than the $21 regular corporate tax.
It’s important to note that deductible payments to a controlled foreign corporation (CFC) are also added back in calculating a taxpayer’s modified taxable income, even if they are included in the taxpayer’s income as Subpart F income. This means it may be advantageous for a U.S. company to organize its foreign operations as a branch instead of conducting operations through a foreign subsidiary.
Another consideration would be restricting intercompany transactions such that related party payments are made from foreign affiliates to the United States, rather than from the United States to the foreign affiliate.
The BEAT can also impact foreign companies with U.S. operations. Foreign companies in the pharmaceutical and technology sectors are especially vulnerable. Its not uncommon for companies in these industries to structure payments from the United States to a foreign parent for the rights to sell software or drugs in the United States, thereby reducing their taxable profit in the United States.
For example, consider a large Japanese software company doing business in the United States through U.S. subsidiaries. The U.S. subsidiaries pay a licensing fee to the Japanese parent company for the right to sell the product in the United States. Under the new law, these payments would be added back to the U.S. subsidiary’s taxable income and are subject to the BEAT. If the BEAT amount exceeds the entity’s regular tax liability, the effective tax rate of the U.S. subsidiary would increase.
Some practitioners are concerned that the new provision could encourage foreign companies to restructure their operations in a manner that would outsource some functions or manufacture more finished products outside the United States to minimize their tax exposure.
In summary, any large company that wants to “defeat the BEAT” will have to review their deductible payments tied to related foreign affiliates, determine if certain exceptions apply, and, if not, evaluate whether restructuring is appropriate to minimize amounts added back taxable income for purposes of the BEAT provisions.
Tara Fisher has been practicing international tax for over 15 years. Her professional background includes working for the U.S. Congress Joint Committee on Taxation, the national tax practice of PricewaterhouseCoopers, the University of Pittsburgh, and American University in Washington D.C.
