New section 59A imposes a minimum tax on domestic corporations with substantial amounts of deductible payments made to related foreign persons (referred to as the base erosion and anti-abuse tax, or BEAT). The BEAT can apply to a US-based multinational if the total amount of such deductible payments for a taxable year is 3 percent or more of total deductions taken into account in calculating taxable income (2 percent for certain banks and securities dealers).
The BEAT is calculated as 10 percent of modified taxable income less the regular tax liability (reduced by certain tax credits including foreign tax credits). Modified taxable income is determined by increasing regular taxable income by current year deductions with respect to payments to related foreign persons and by the portion of an allowed net operating loss resulting from such payments. The amounts added back include payments for certain services, interest, rents and royalties (but not payments for inventory).
Deductible payments made to a related controlled foreign corporation (CFC) can be counted twice in calculating the BEAT. First, such payments may give rise to Subpart F income or global intangible low-taxed income (GILTI), which would be included in the regular and modified taxable income of the US shareholder. In addition, the amount of the deductible payments would be added back to regular taxable income in calculating modified taxable income. For example, $10 million of royalties paid to a CFC by a domestic corporation may be included in income as Subpart F income, and the royalty payment also would not be deductible in calculating modified taxable income (i.e., the $10 million royalty payment would be added back, resulting in $20 million of modified taxable income).
The BEAT is particularly onerous if the CFC’s income is subject to foreign taxation because, while foreign income taxes can be used as a credit to reduce regular tax liability, no foreign tax credit is permitted to offset the BEAT, and the gross-up for deemed paid taxes is included in modified taxable income. Assume the CFC paid a foreign income tax at a 16 percent rate on the $10 million of Subpart F royalty income (and, assuming the royalty expense reduced income other than Subpart F income, the regular US tax on the Subpart F income is reduced to 5 percent with foreign tax credits). If the domestic corporation is subject to the BEAT, it would effectively pay another 15 percent US tax on the $10 million of system-wide intangible income ($20 million modified taxable income x 10 percent less 5 percent regular tax liability), resulting in an overall 36 percent global effective tax rate (i.e., 5 percent regular tax liability on subpart F income, 15 percent BEAT, and 16 percent foreign income tax).
US-based multinationals subject to the BEAT should analyze the results of payments to CFCs and may consider restructuring to fall below the 3 percent threshold or minimize the impact of Subpart F. This may include structuring service payments to qualify for the services cost method exception, capitalizing certain amounts into costs of goods sold, netting cross payments, paying foreign third parties directly, or electing to disregard a foreign entity. Any restructuring steps will need to take into account the application of other tax rules, as well as the potential exercise of the IRS’s broad anti-avoidance regulatory authority under the BEAT.