The US Base Erosion and Anti-Abuse Tax

The US Tax Cuts and Jobs Act (Pub. L. no. 115-97) introduces a base erosion and anti-abuse tax (BEAT) regime, which imposes a minimum tax on large corporations that reduce their US tax liability by making deductible base erosion payments (for example, interest, management fees, or royalties) to related entities. The BEAT regime is generally applicable for payments made or accrued in tax years beginning after December 31, 2017. The BEAT and other provisions of the Tax Cuts and Jobs Act essentially replicate the intent of the OECD's Multilateral Convention To Implement Tax Treaty Related Measures To Prevent Base Erosion and Profit Shifting, although the United States is not a signatory.

The BEAT (IRC section 59A) is generally applicable to corporate taxpayers that (1) are not taxed on a flowthrough basis; (2) are part of a group with at least $500 million in average annual US gross receipts for the prior three-year period ("the US gross receipts test"); and (3) have a base erosion percentage (see below) of 3 percent or more. The BEAT also applies to foreign corporations that are engaged in a US trade or business for the purposes of determining their ECI (effectively connected income) tax liability. However, the US income generated by a foreign corporation that is exempt under a comprehensive treaty between the United States and the corporation's foreign country of residence is likely not to be counted in the US gross receipts test, although this is not made explicit in the legislation.

For these purposes, a taxpayer's base erosion percentage is derived by dividing the deductions taken for base erosion payments to related foreign persons by the aggregate deductions allowable to the US taxpayer (excluding net operating losses carried back or forward and certain other items). In general, "base erosion payments" are any amounts paid or accrued to a related foreign person for which a deduction is allowed, as well as (1) payments for acquisitions of depreciable or amortizable property from related persons, (2) certain reinsurance premiums paid to foreign related parties, and (3) costs of goods sold for corporations that are inverted after November 9, 2017.

A "foreign related party" is defined in IRC section 6038A and includes any 25 percent foreign shareholder of the taxpayer, a person related thereto, and any other person related to the taxpayer under the rules of IRC section 482.

The BEAT liability is computed through a multi-step formula used to derive the base erosion minimum tax amount, to which a rate of 5 percent is applied for tax years beginning in 2018 (the BEAT rate is increased to 10 percent for tax years beginning during 2019-2025 and 12.5 percent for tax years beginning after December 31, 2025). The "base erosion minimum tax amount" equals the excess of 10 percent of the taxpayer's modified taxable income (MTI) for the year in question over an amount equal to the taxpayer's pre-credit regular income tax liability reduced by certain credits.
BEAT minimum tax amount = 10% of MTI − (regular tax liability − certain tax credits)
The taxpayer's MTI is the taxpayer's taxable income, with the base erosion tax benefit amount (including the base erosion percentage of a net operating loss deduction) added back.

In the absence of a treaty override provision, US legislation and treaties are on equal footing for US taxation purposes. Therefore, the BEAT may raise issues regarding its treatment from a tax treaty perspective because legislation might result in conflicting interpretations (for example, non-discrimination clauses: the BEAT effectively denies a portion of the deductions for payments made to foreign entities when payments made to domestic entities remain fully deductible). Additional guidance is expected to clarify any conflicts between the BEAT and US tax treaties.

Justine Morin
KPMG LLP, Montreal

Canadian Tax Focus
Volume 8, Number 2, May 2018
©2018, Canadian Tax Foundation