2 December 2019 was a fruitful day for the international tax community and multinational enterprises. Two hours apart, the U.S. Treasury Department and IRS released guidance on two significant international tax provisions: the base erosion and anti-abuse tax (BEAT) and the foreign tax credit (FTC).
New BEAT regulations
In an attempt to curtail businesses from shifting profits to lower tax jurisdictions, the Tax Cuts and Jobs Act (TCJA) of 2017 introduced the base erosion and anti-abuse tax. The BEAT is primarily directed at large U.S. resident corporations with gross receipts averaging above $500 million for the prior three years that also make deductible payments in the form of interest, royalties and certain service payments to non-resident affiliates. For the BEAT to apply, deductible payments to foreign related parties must exceed 3 percent of total deductions (known as the base erosion percentage). The BEAT is an add-on tax calculated on modified taxable income at the following gradually increasing rates: 5 percent in fiscal year 2018; 10 percent from 2019 through 2025; and 12.5 percent from 2026 onward.
The final regulations largely echo the 2018 proposed regulations, with certain revisions. Here are some of the key changes:
- Amounts transferred to or exchanged with a foreign related party in Section 331, 351, 355 and 368 transactions (referred to as specified nonrecognition transactions, or SNTs) are generally excluded from the definition of a base erosion payment;
- Section 301 distributions do not impact a base erosion payment;
- Loss on the transfer of property to a foreign related party is not treated as a base erosion payment;
- The with-or-within method is used to calculate the base erosion percentage and gross receipts for members of an aggregate group with a tax year different from the taxpayer;
- No penalties will be imposed under Sections 6038A(d) and 6038C(c) if corrections are made by 6 March 2020;
- There are also significant revisions for partnerships, financial institutions and consolidated entities.
The major theme of the 2019 proposed regulations is the election to waive allowed deductions, which could result in either eliminating or reducing BEAT liability and should be made on Form 8991. The proposed regulations specify that the following information must be lodged with the form:
- Detailed description of the item to which the deduction relates;
- Date of payment or accrual;
- Amount of deduction and amount being waived;
- Code provision that allows the deduction;
- Schedule and line number of the deduction on the federal income tax return;
- Certain information on the foreign related party generating the deduction.
The election can be made on an originally filed return, on an amended return or during the course of an IRS examination.
Among the provisions requested by the public during the commentary process but not adopted is the treatment of net operating loss carryovers in computing modified taxable income. Base erosion payment exceptions for payments to controlled foreign corporations or passive foreign investment companies were also not adopted.
6 December 2019 is the effective date of the final regulations. The 2019 proposed regulations are available for public comments until 4 February 2020.
Generally the final regulations apply for tax years ending on or after 17 December 2018. The 2019 proposed regulations can be retroactively applied in their entirety for taxable years beginning after 31 December 2017 and before they are finalized; or they can be applied prospectively after they are finalized. Moreover, the 2018 proposed regulations can be applied in their entirety for all tax years ending on or before 6 December 2019. Taxpayers may therefore choose to rely on either the final regulations or the 2018 or 2019 proposed regulations and amend returns if necessary.
New FTC regulations
The foreign tax credit is a benefit for those paying and accruing taxes in foreign jurisdictions. Following the enactment of the TCJA, FTCs have undergone key changes. Some of these changes limit the use of credit available to taxpayers and further complicate an already complex regulatory area.
The final FTC regulations under Sections 861, 901, 904, 905, 954, 960, 965, 986 and 988 were issued — like the BEAT legislation — in conjunction with the proposed regulations. The final regulations contain many provisions of proposed regulations issued in December 2018, as well as regulations issued in 1988 (related to expense allocation rules), 2007 (Section 905(c)) and 2012 (concerning overall foreign loss), with few notable changes.
The 2019 proposed regulations focus on allocation and apportionment of foreign taxes and certain expenses, such as those related to R&D, interest and stewardship. They also address net operating loss (NOL), overall foreign loss (OFL), separate limitation loss (SLL) and overall domestic loss (ODL) ordering rules, as well as foreign tax redemptions.
The final regulations are expected to be published in the Federal Register by the end of this year. The 2019 proposed regulations are available for public comments until 5 February 2020.
Businesses subject to the BEAT and eligible for FTCs should immediately review the new regulations to understand how they impact their current tax positions. Existing policies and procedures should be adjusted as necessary.
Businesses should also note that U.S. authorities have not yet issued much-anticipated guidance on some other important international tax provisions, including the following: the global intangible low-taxed income (GILTI) high-tax exception; the application of dividend received deductions at the controlled foreign corporation level (Section 245A); and previously taxed earnings and profits (PTEP). Guidance in these areas will likely be issued in early 2020. Potentially affected organizations should monitor regulatory releases to keep abreast of the changes and understand how they will affect current tax positions and modelling.
Hanna Mialik, Senior Associate, Corporate and International Tax Advisory, contributed to this article.
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