The ability of taxpayers to waive deductions in order to ensure that they are not subject to the base-erosion and anti-abuse tax (BEAT) was confirmed in final regulations under section 59A issued on September 1, 2020 (Final Regulations). The Final Regulations also finalized proposed rules related to the determination of the taxpayer’s “aggregate group” for purposes of applying section 59A. The Final Regulations follow closely proposed regulations that were issued in conjunction with final regulations on December 6, 2019 (see prior coverage here), but with some notable changes, including:
- Clarifying that the BEAT waiver election is only available to a taxpayer that otherwise could be an “applicable taxpayer” for BEAT purposes, and that deductions may be waived in part for this purpose;
- Allowing the waiver of amounts treated as reductions to gross premiums and other consideration, consistent with other deductible payments that may be waived;
- Addressing taxpayer comments regarding the impact on the aggregate group calculations of short taxable years of members, members joining and leaving the group, and predecessors and successors;
- Adopting an end-of-day rule (rather than a time-of-transaction rule) with respect to the deemed taxable year-end occurring when members leave/join an aggregate group; and
- Modifying the anti-abuse rules for basis step-up transactions to exclude transactions with relatively nominal step up.
The BEAT and the proposed regulations
Generally speaking, the BEAT functions as a minimum tax on corporations that have annual average gross receipts over a three-year period ending with the prior taxable year of at least $500 million, and have a “base erosion percentage” of at least 3% (or 2% in the case of banks and registered securities dealers). A corporation meeting the above thresholds is considered to be an “applicable taxpayer.” Whether an “applicable taxpayer” is subject to the BEAT is determined by comparing its “modified taxable income” multiplied by the applicable BEAT tax rate for the taxable year to the taxpayer’s regular tax liability for the taxable year without taking into account certain credits.
The applicable BEAT tax rate was 5% for tax years beginning in 2018, and is 10% for tax years beginning after 2018 and before 2025, and 12.5% for tax years beginning after 2025 (or 6%, 11% and 13.5%, respectively, in the case of banks and registered securities dealers). If a taxpayer’s regular tax liability exceeds the modified taxable income multiplied by the applicable BEAT tax rate, there is no BEAT liability (i.e., no tax is imposed under Code section 59A).
In December 2019, the IRS issued final regulations implementing section 59A, along with proposed regulations that would allow taxpayers to waive allowable deductions in order to ensure that they have a base erosion percentage below the relevant threshold (i.e., 3 percent generally, and 2 percent in the case of banks and registered securities dealers). A waived deduction is waived for all US federal income tax purposes. Significantly, deductions are permitted to be waived on an initial return, an amended return, or on audit. But, once a deduction has been waived, the taxpayer is not permitted to reverse the waiver without the consent of the IRS.
The proposed regulations also included guidance regarding how a taxpayer determines its aggregate group, including rules relating to short taxable years, members joining and leaving a taxpayer’s aggregate group, and predecessors and successors. In the case of short taxable years, the proposed regulations required a taxpayer to use a reasonable approach to determine the gross receipts and base erosion percentage of the aggregate group for the short taxable year, such that it does not under-count or over-count the taxpayer’s gross receipts, base erosion tax benefits and deductions. As to members joining and leaving an aggregate group, the Proposed Regulations provided a cut-off rule that deem a year-end to occur when a member joins or leaves the aggregate group, and allocates gross receipts, deductions and base erosion tax benefits based on this deemed year-end approach. In the case of predecessors and successors, the proposed rules provided that a reference to a taxpayer includes a reference to any predecessor of the taxpayer, such as in a section 381 transaction.
The final final BEAT regulations . . , For now
As noted above, the Final Regulations adopt the proposed regulations with some limited clarifications and modifications in response to comments received.
BEAT waiver election
The Final Regulations adopt with limited changes the waiver election from the proposed regulations. The waiver election is intended to minimize the harsh “cliff effect” of failing the base erosion percentage test. If a taxpayer elects to waive a deduction, such forgone deduction will not be treated as a base erosion tax benefit, and will not be treated as deductible for any US federal income tax purposes.
Regarding eligibility to make the election, the Final Regulations explicitly clarify that, in order to make or increase the BEAT waiver election under Treas. Reg. § 1.59A-3(c)(6), the taxpayer must determine that the taxpayer could be an applicable taxpayer for BEAT purposes but for the BEAT waiver election. Treas. Reg. § 1.59A-3(c)(6)(i). In other words, the taxpayer must have concluded that but for the election, it would have a BEAT percentage of greater than 3 percent (or 2 percent in certain cases). The preamble to the Final Regulations also reiterates that the BEAT waiver election does not affect any existing law addressing “waiver” of deductions outside of the specific situation covered by the BEAT waiver.
The Final Regulations retain the rule that a taxpayer may only make or increase a waiver election on an amended return or on audit. The IRS and Treasury rejected comments requesting that taxpayers also be permitted to reduce a waived deduction on an amended return or on audit. The preamble to the final regulations explains that the ability to reduce a waived deduction does not further the policy goal of addressing the cliff effect of applicable taxpayer status under section 59A. It also expressed concern that expanding electivity would result in increased uncertainty to the IRS in assessing tax return positions, and could have a negative impact on examinations.
In response to comments, the Final Regulations clarify that a deduction may be waived in part (see Treas. Reg. § 1.59A-3(c)(6)(i); see also Treas. Reg. §§ 1.59A-3(c)(6)(ii)(B)(4) and (5), and 1.59A-3(c)(6)(iii)(B)). According to the preamble, the IRS plans to revise Form 8991, Tax on Base Erosion Payments of Taxpayers with Substantial Gross Receipts, to incorporate reporting requirements relating to the reporting of deductions that taxpayers have partially waived. The broad documentation requirements of the proposed regulations generally are retained in the Final Regulations. Treas. Reg. § 1.59A-3(c)(6)(ii)(B)
In a change of considerable importance to insurance companies, the Final Regulations also broadened the definition of allowed deductions to include “amounts treated as reductions to gross premiums and other consideration” on insurance and annuity contracts. It had previously been unclear whether an insurance company could waive such amounts because these amounts are treated under the subchapter L rules as reductions to adjusted gross income rather than deductions. Thus, such amounts technically did not fit within the definition of an allowed deduction that could be waived under the proposed regulations. Treasury and the IRS reasoned that there was no policy reason to treat amounts treated as reductions to gross premiums differently from a “deduction” for any other taxpayer. However, Treasury and the IRS did state that the waiver of a reduction to gross premiums and other consideration does not reduce the amount of any insurance premium payments subject to excise tax under section 4371.
Changes also were made in the Final Regulations to allow a corporate partner in a partnership to waive deductions that are allocated from the partnership, subject to certain special rules in connection with the centralized partnership audit regime. Treas. Reg. § 1.59A-3(c)(6)(iv)(A). The Final Regulations further clarify that it is the partner, not the partnership that makes a BEAT waiver election (see Treas. Reg. § 1.59A-3(c)(6)(iv)(A)), provide that waived deductions are treated as non-deductible expenditures under Code section 705(a)(2)(B) (see Treas. Reg. § 1.59A-3(c)(6)(iv)(B)), and adopt rules to conform the partner-level waiver with Code section 163(j) (see Treas. Reg. § 1.59A-3(c)(6)(iv)(C)).
In the case of consolidated groups, the Final Regulations clarify that waived deductions attributable to a consolidated group member are treated as noncapital, nondeductible expenses that decrease the tax basis in the member’s stock for purposes of the stock basis rules in Treas. Reg. § 1.1502-32 to prevent the shareholder from subsequently benefitting from a waived deduction when disposing of the member’s stock. See Treas. Reg. § 1.59A-3(c)(6)(iii)(A)(4).
Determination of taxpayer’s aggregate group
For taxpayer’s with a short taxable year, the Final Regulations retain the rule that permits the use of a “reasonable approach” to determine the gross receipts and base erosion percentage of its aggregate group members for the short taxable year, which would neither over-count nor under-count the gross receipts, base erosion tax benefits, and deductions of the members of the taxpayer’s aggregate group. Treas. Reg. § 1.59A-2(c)(5)(i)(B). But, in response to comments, the Final Regulations clarify that an approach that excludes gross receipts, base erosion tax benefits, and deductions of an aggregate group member from ever being taken into account is not a reasonable approach. The Final Regulations also include examples of methods that may or may not constitute a reasonable approach.
The Final Regulations make a slight modification of the rules for members that leave or join an aggregate group, adopting a “close of the day” rule instead of the “time of the acquisition” rule in the proposed regulations for purposes of when the member’s year is deemed to end. The close of the day rule is in line with other similar rules in the consolidated return context. In addition, to address concerns regarding the potential for members with short taxable years leaving or joining the aggregate group, the Final Regulations require that gross receipts, beat deductions, and deductions of relevant companies to be annualized in certain cases. The annualization rule applies if a member of a taxpayer’s aggregate group has more than one taxable year that ends with or within the taxpayer’s taxable year, and together those taxable years are comprised of more than 12 months, or if a member has a short taxable year. See Treas. Reg. § 1.59A-2(c)(5)(ii)(B). Anti-abuse rules also are included to prevent transactions aimed at excluding gross receipts or base erosion percentage items of a taxpayer or a member of the taxpayer’s aggregate group, undertaken with a principal purpose of avoiding applicable taxpayer status. See Treas. Reg. § 1.59A-2(c)(5)(iii).
The only significant change to the predecessor successor rules in the Final regulations is to clarify that in determining relevant gross receipts, gross receipts of foreign predecessor corporations are taken into account only to the extent they constitute ECI of such foreign predecessor corporations. See Treas. Reg. § 1.59A-2(c)(6)(i).
Nonrecognition transactions anti-abuse rule
The Final Regulations also modify an anti-abuse rule related to non-recognition transactions that was included in the regulations that were finalized in 2019. Specifically, under those regulations deductions attributable to assets acquired in a nonrecognition transaction, such as a section 332 liquidation, a section 368 reorganization or a section 351 transaction, are not considered to be base erosion payments. But, an anti-abuse rule applies if there is a transaction that is undertaken with the principal purpose of increasing the adjusted basis of property acquired in such a nonrecognition transaction. The anti-abuse rule includes an irrebuttable presumption that a transaction undertaken within 6 months prior to the acquisition of the property has a principal purpose of tax avoidance. See Treas. Reg. § 1.59A-9(b)(4).
To avoid creating a “cliff effect” whereby a minimal amount of pre-transaction basis step-up could disqualify an entire transaction that would have otherwise qualified for the specified nonrecognition transaction exception, the Final Regulations revise the anti-abuse rule to the effect that when it applies, the specified nonrecognition transaction exception applies except to the extent of such basis step-up amount. The Final Regulations further clarify that the transaction, plan, or arrangement with a principal purpose of increasing the adjusted basis of property must also have a connection to the acquisition of the property by the taxpayer in a specified nonrecognition transaction.
Applicability date
The Final Regulations generally apply to taxable years beginning on or after the date of publication in the Federal Register. However, taxpayers may apply the Final Regulations in their entirety for taxable years beginning after December 31, 2017, and before their applicability date, provided that, once applied, taxpayers must continue to apply these regulations in their entirety for all subsequent taxable years. Special applicability rules are provided for certain rules relating to partnerships, certain rules relating to the BEAT waiver election, as well as certain rules of the prior proposed regulations.
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