Base Erosion and Anti-Abuse Tax (“BEAT”)

Under the Tax Cuts and Jobs Act, U.S. corporate shareholders of a foreign business can now deduct any dividends received when computing corporate taxable income. Because this deduction can reduce U.S. tax on foreign profits, Congress created a mechanism to deter U.S. corporations from eroding the U.S. tax base by paying tax-deductible expenses to foreign affiliates then distributing profits tax-free. The deterrent is essentially a new form of an alternative minimum tax that applies to large multinational corporations and was quickly given the acronym “BEAT.” The BEAT is effective for tax years beginning after December 31, 2017.

When Does BEAT apply?

• Average annual gross receipts of $500,000,000 for the prior three-year period; AND 
• A base erosion percentage of at least 3% (2% in the case of banks and securities dealers)

BEAT does not apply to RICs, REITs or S Corporations.  

$500 Million of Average Annual Gross Receipts

To determine if a corporation exceeds the average annual gross receipts threshold for the preceding three-year period, gross receipts are determined on an affiliated group level, including all businesses with common 50% ownership with the taxpayer. Foreign corporations are included in the affiliated group if they meet the 50% ownership test. Although affiliated group rules also apply to other tax concepts, a key distinction for the BEAT is that in applying the affiliated group rules in the case of a foreign taxpayer or affiliate, only the gross sales that generate U.S. effectively-connected income are taken into account. Because non-U.S. sales are removed from the computation, large multinational corporations with smaller U.S. businesses will likely be exempt from the tax.

Base Erosion Percentage of At Least 3%

Only taxpayers with a base erosion percentage of at least 3% are liable for BEAT. Determining the base erosion percentage first requires identification of the components of the calculation:

A “base erosion payment” is any amount paid or accrued by a taxpayer to a foreign related party for which a deduction is allowable. This includes a purchase from a foreign related party of depreciable property. 

“Related party” for this purpose is very broadly defined to include any 25% owner, any person related to the taxpayer or 25% owner, and any other person related under IRC §482.  A “25% owner” is a person that owns 25% of the total voting power of all classes of stock of a corporation entitled to vote or 25% of the total value of all classes of the corporation’s stock. Constructive ownership rules will apply and will include 10% shareholders as opposed to 50% shareholders.

• Pursuant to the Committee Report, payments for inventory are not base erosion payments as they are considered reductions of income rather than deductions.
• Amounts paid or accrued to a related party for services are excluded if the amounts meet the requirements for using the services cost method under §482 and the payment is for total services costs with no markup component;
• Certain “qualified derivative payments” where the underlying derivative is annually marked to market are excluded

Once the base erosion payments to foreign-related parties have been identified, the taxpayer’s “base erosion tax benefit” and “base erosion percentage” are determined.

• For payments to foreign affiliates for purchases of depreciable property, only the depreciation deduction as computed for purposes of the BEAT liability (described below) is taken into account, rather than the entire purchase price. 
• Any payments that have been subject to U.S. tax and for which tax was withheld under §§1441 or 1442 are excluded.

• Net Operating Losses
• New §250 Payments (“FDII Deduction”)
• New §245A Payments (Deduction for foreign-source portion of dividends)
• Deductions for Services Not Treated as a Base Erosion Payment
• Deductions for Qualified Derivative Payments Not Treated as a Base Erosion Payment

Results of Step 2 are divided by the results of Step 3. If the percentage is at least 3%, the taxpayer has met the Base Erosion Percentage requirement.

How is BEAT Computed?

BEAT is equal to 10% of the taxpayer’s “modified taxable income” (5% for 2018; 12.5% after 2025), less a portion of some tax credits. “Modified taxable income” is determined as follows:

Once a taxpayer has determined that BEAT is applicable, the tax computed under BEAT is compared to the taxpayer’s regular tax liability. If BEAT is higher, the taxpayer pays the additional tax computed under BEAT.

Additional Reporting Requirements 

The law adds additional reporting related to BEAT under IRC §6038A, the current regime for Form 5472 reporting. While the specific requirements are not yet identified, reporting will include information that is necessary to determine the base erosion minimum tax amount, base erosion payments, and base erosion tax benefits for the tax year. Penalties related to this reporting have been increased from $10,000 to $25,000 per form. 

This information is based on the statutes and guidance available as of the date of publication (January 2018) and is subject to change.