February 7, 2018
Mark W. Wolfgram
BelBrands USA, Inc.
The Tax Cuts and Jobs Act is perhaps the biggest alteration to the tax code since 1986. The changes hit all aspects of the tax spectrum, leaving taxpayers and tax advisors scrambling to review the changes to determine what the impact will be. Today we’ll focus on a new international provision designed to raise revenue in 2018 and beyond called the Base Erosion Anti-Abuse Tax (or “BEAT”).
BEAT’s concept is to discourage base erosion payments from U.S. corporations to their international affiliates. BEAT accomplishes this by imposing a new minimum tax for corporations making these otherwise deductible payments to foreign-related entities. BEAT will be particularly impactful for inbound corporations but can apply to a broad range of corporations. Let’s look at the mechanics of how BEAT works.
Who is subject to BEAT?
Domestic C corporations must pass two tests for BEAT to be applicable. First, the corporation must have average gross receipts (measured over a three-year period) of $500 million or more. Second, the corporation must have base erosion payments which are at least 3% of total deductions.
What are base erosion payments?
Base erosion payments are meant to be all-encompassing so the definition is broad. The definition includes any payments made to foreign-related entities (see Section 6038A for definition) with a few exceptions. The most notable exception is for cost of goods sold (“COGS”). Further exceptions exist for payments for services charged with no-markup, certain qualified derivative payments, and payments subject to U.S. withholding tax (though payments where the withholding tax is reduced by tax treaty are not eligible for this exception). Base erosion payments also include certain reductions in gross receipts.
How is BEAT computed?
Corporations meeting both the gross receipts and base erosion payment percentage test will need to perform a separate calculation to determine if/how much BEAT owed. This would be similar to performing an alternative minimum tax calculation in prior years for a corporation or an individual. Corporations would start with “normal” taxable income reported on the Form 1120 and add-back all applicable base erosion payments to determine a “modified” taxable income for BEAT purposes. Taxpayers would then apply the BEAT rate against the modified taxable income to determine the BEAT. Taxpayers will pay BEAT or regular income tax, whichever is greater.
What is the BEAT rate?
The BEAT rate is 5% for 2018, 10% for 2019 through 2025, and 12.5% for years after 2025.
Can we look at a simple 2018 example?
Corporation A reported $20M of regular taxable income and $4M of regular income tax on its 2018 Form 1120. Assume corporation A meets both the gross receipts and base erosion payment percentage test. Included in the $20M of regular taxable income was a deduction for $40M of base erosion payments. Therefore, the modified taxable income for BEAT purposes is $60M. The BEAT rate in 2018 is 5% so the BEAT for 2018 would be $3M. Because the BEAT of $3M is smaller than the regular income tax of $4M, corporation A pays only the regular income tax of $4M.
What happens to this example in 2019?
Assume the same facts as the 2018 example. The BEAT rate in 2019 is 10% so the BEAT for 2019 would be $6M. Because the BEAT of $6M is higher than the regular income tax of $4M, corporation A would pay an additional $2M in federal tax due to the BEAT.
Please note there are special rates and rules for certain banks, securities dealers, and insurance companies which differ from the general rules outlined above. Taxpayers in those service areas should review the rules carefully.
BEAT will have wide-ranging impacts right away in 2018. BEAT will need to be factored in when making estimated quarterly income tax payments and included in any quarterly income tax provisions for financial statement purposes.
Like many of the new tax provisions, BEAT will need to be defined further by regulations and/or tax technical corrections. Specifically, what is the definition of COGS? Is this provision legal from a worldwide trade perspective? How are companies with Advanced Pricing Agreements impacted? Is other transition guidance needed? Watch this space for further updates.