Article featured in Thomson Reuters' Taxnet Pro, September 2020

On Tuesday, the Treasury and IRS released final regulations dealing with certain aspects of the base erosion and anti-abuse tax (BEAT) that had been addressed in proposed regulations published back in December of 2019. 

The BEAT is imposed by section 59A, which was added to the Code as part of TCJA. While TCJA removed the alternative minimum tax for corporations, it added the BEAT, which operates as a minimum tax for certain corporations (other than RICs, REITs, and S corporations) that are sufficiently large (based on a gross receipts test) and whose base erosion percentage (which measures the amount of deductible payments, such as interest, royalties, and certain service payments, made to foreign related parties in whose hands those payments are not subject to U.S. tax) is three percent or higher. 

The determinations whether a corporation is sufficiently large and whether it has made a sufficiently large amount of base eroding payments take into account the gross receipts and deductions of the taxpayer and all other members of the taxpayer’s “aggregate group.”  

The new final regulations adopt, with some revisions, the December 2019 proposed regulations. Those revisions are focused primarily around:

• The taxpayer’s right to waive deductions;
• Adjustments to deal with various complications that can arise in computing aggregate group gross receipts and deductions; and  
• Application of the BEAT to situations involving partnerships.

Taxpayer Right to Waive Deductions

Perhaps the most controversial aspect of the 2019 proposed regulations was their explicit allowance of a taxpayer’s waiver of deductions. By waiving otherwise base-eroding deductions, a taxpayer can avoid crossing the threshold which would subject them to the BEAT. Without a deduction waiver, the application of the BEAT would involve the distinct possibility of a so-called cliff effect, under which as little as $1 in incremental base erosion benefit could trigger a tax of many millions of dollars. However, it was unclear whether the regulations intended to allow the waiver only in circumstances in which it would impact the applicability of the BEAT or in all situations (e.g., could a CFC waive a deduction to avoid generating a  tested loss, so that its U.S. shareholders can utilize its QBAI in their calculation of GILTI).

Although this right to waive deductions was widely viewed as a new and unusual planning opportunity granted by the IRS under its regulatory authority, perhaps the most controversial aspect of this opportunity relates to the fact that at least a few practitioners believe that taxpayers already had this right, long before the BEAT regulations, based on pre-existing statutory language. Very briefly, the argument is that although the language of the tax code imposes a strict obligation on taxpayers to completely and accurately report all of their gross income, it does not (as a general rule) impose any obligation on taxpayers to claim all “allowable” deductions. Rather, in the case of deductions, the tax code imposes the obligation on the IRS (not the taxpayer) to “allow” deductions claimed by taxpayers if and to the extent those deductions are “allowable”. Thus, in the case of deductions, the argument goes, the only legal obligation imposed on the taxpayer is to limit its claims to those which are allowable by law.[1] Whatever the merits of this argument as a general matter, it appears to be forestalled in the BEAT context by the final regulations.

The new final regulations retain the taxpayer right to waive deductions that were contained in the proposed regulations, with some clarifications around when and how a taxpayer can make use of that right, including the following:

• Taxpayers can only make the BEAT waiver election if their base erosion percentage is three percent or higher prior to the election.
• Contrary to the argument outlined above, the regulations take the position that the BEAT waiver election is the sole method by which a deduction that could be properly claimed by a taxpayer for the taxable year is not taken into account for BEAT purposes.
• Taxpayers can increase the amount of waived deductions on an amended return or during an IRS exam.
• Taxpayers may not decrease the amount of waived deductions on an amended return or during an IRS exam.
• Deductions waived pursuant to the BEAT waiver election should be included in the denominator of the base erosion percentage.
• Taxpayers can waive benefits for certain non-life reinsurance premium payments that are, as a technical matter, not deductions.
• A corporate partner, and not a partnership, can make the BEAT waiver election with respect to partnership deductions, and waived deductions still reduce the basis of the waiving partner’s interest in the partnership. 
• A deduction to which the BEAT waiver election applies reduces the basis of the stock of the member of a consolidated group that incurred the deduction.
• Documentation requirements for the waiver election. 

A&M Insight: The ability of taxpayers to waive deductions for purposes of the BEAT can present a very powerful planning opportunity. Due to the Covid-19 Pandemic, many companies are facing difficult cash flow issues. The BEAT can create scenarios where U.S. corporations, which are currently incurring losses (or are offsetting their U.S. taxable income with NOL carryforwards), and hence are not subject to U.S. “regular” income tax, may be subject to BEAT, which creates a current tax liability. For these companies, it may be beneficial to waive deductions to reduce or eliminate the current BEAT liability and retain cash. That being said, these companies must also consider the possibility of increasing U.S. Federal income tax rates in the near future (in which case NOL carryforwards will be more valuable and can be increased by not waiving the deductions). At the end of the day, there is no one-size-fits-all approach to deciding whether to waive deductions for purposes of the BEAT. A&M Taxand is currently working with our clients to model the effects of waiving (or not waiving) deductions for purposes of the BEAT.

Rules Dealing with Aggregate Group Complexities

For a taxpayer to determine whether it satisfies the $500 million gross receipts test and the 3% base erosion percentage test to be subject to the BEAT, it must determine whether it is a member of an “aggregate group.”  The definition of an “aggregate group” applies the same aggregation rules as the Employee Retention Credit of the CARES Act and the definition of an exempt entity for purposes of section 163(j), which was also added by TCJA. 

Sounds simple right? All we have to do is identify the aggregate group members, under a pre-existing set of rules; and then add up the gross receipts and deductions of those members. Not so fast! As the tax law has driven home in countless other situations, the devil (i.e. the complexity) is in the details. The following aggregate group complexities, many of which have to do with matching up taxable years of aggregate group members, are dealt with in the details of the final regulations (and unfortunately, are explicitly applicable only for purposes of the BEAT):

• Correction of over- and under-counting of gross receipts when aggregate group members have different taxable years;
• Treatment of members leaving or joining an aggregate group during the taxable year or base period year;
• How to take into account gross receipts, base erosion tax benefits, and deductions of aggregate group members when the taxpayer has a short taxable year or base period year within which the tax years of one or more group members do not end;
• Deferred deductions (e.g., 163(j) interest deduction deferrals) of group members;
• Predecessor and successor corporations;
• Taxpayers or group members that are foreign corporations;
• Revoking elections and retroactive elections in connection with bonus depreciation and research and experimentation capitalization and amortization.

While the final regulations deal with each of these complexities with a very logical and noncontroversial set of rules that match the gross receipts and deductions of group members in each of the above situations (e.g., annualization rules to deal with tax year differences), their application is dependent on a taxpayer’s specific facts. 

Other Issues Addressed by the Final Regulations

In addition to the matters discussed above, the final regulations also address a few other issues, including:

• The application of the BEAT provisions to partnerships (beyond the deduction waiver).
• Anti-abuse rules for basis step-up transactions undertaken in advance of certain specified nonrecognition transactions that would otherwise qualify for an exception from base erosion treatment.
• The final regulations are generally applicable to taxable years ending on or after December 2, 2019, with the possibility to apply all or certain portions of the regulations to prior taxable years.

A&M Taxand Says

Taxpayers are likely to find much of what is contained in the final regulations to be welcome additions and clarifications, although their application is highly fact-dependent (as illustrated above when determining whether or not waive deductions). As always, we are available to assist clients in understanding the details of these regulations and how those details impact them. 

[1] For more on that, see Letter to the Editor of Tax Notes, Anonymous, Perjury for Not Claiming Every Allowable Deduction? Really? 13 Tax Notes 567 (Oct. 29, 2012).