Base Erosion and Anti-Abuse Tax

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9885]

RIN 1545-BO56

Base Erosion and Anti-Abuse Tax

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations.

SUMMARY:

This document contains final regulations implementing the base erosion and anti-abuse tax, designed to prevent the reduction of tax liability by certain large corporate taxpayers through certain payments made to foreign related parties and certain tax credits. These final regulations also provide reporting requirements related to this tax. This tax was added to the Internal Revenue Code (the “Code”) as part of the Tax Cuts and Jobs Act. This document finalizes the proposed regulations published on December 21, 2018. The final regulations affect corporations with substantial gross receipts that make payments to foreign related parties. The final regulations also affect any reporting corporations required to furnish information relating to certain related-party transactions and information relating to a trade or business conducted within the United States by a foreign corporation.

DATES:

Effective date:

The final regulations are effective on December 6, 2019.

Applicability dates:

For dates of applicability, see §§ 1.59A-10, 1.1502-2(d), 1.1502-59A(h), and 1.6038A-2(g).

FOR FURTHER INFORMATION CONTACT:

Concerning §§ 1.59A-1 through 1.59A-10, Azeka J. Abramoff, Sheila Ramaswamy, or Karen Walny at (202) 317-6938; concerning the services cost method exception, L. Ulysses Chatman at (202) 317-6939; concerning §§ 1.383-1, 1.1502-2, 1.1502-4, 1.1502-43, 1.1502-47, 1.1502-59A, 1.1502-100, and 1.6655-5, Julie Wang at (202) 317-6975 or John P. Stemwedel at (202) 317-5024; concerning §§ 1.6038A-1, 1.6038A-2, and 1.6038A-4, Brad McCormack or Anand Desai at (202) 317-6939 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

On December 21, 2018, the Department of the Treasury (“Treasury Department”) and the IRS published proposed regulations (REG-104259-18) under section 59A, and proposed amendments to 26 CFR part 1 under sections 383, 1502, 6038A, and 6655 in the

Federal Register

(83 FR 65956) (the “proposed regulations”). The base erosion and anti-abuse tax (“BEAT”) in section 59A was added to the Code by the Tax Cuts and Jobs Act, Public Law 115-97 (2017) (the “Act”), which was enacted on December 22, 2017. The Act also added reporting obligations regarding this tax for 25-percent foreign-owned corporations subject to section 6038A and foreign corporations subject to section 6038C.

A public hearing was held on March 25, 2019. The Treasury Department and the IRS also received written comments with respect to the proposed regulations. Comments outside the scope of this rulemaking are generally not addressed but may be considered in connection with future guidance projects. All written comments received in response to the proposed regulations are available at

www.regulations.gov

or upon request.

Summary of Comments and Explanation of Revisions

I. Overview

The final regulations retain the basic approach and structure of the proposed regulations, with certain revisions. This Summary of Comments and Explanation of Revisions discusses those revisions as well as comments received in response to the solicitation of comments in the notice of proposed rulemaking accompanying the proposed regulations.

II. Comments and Changes to Proposed § 1.59A-1—Overview and Definitions

Proposed § 1.59A-1 provides general definitions under section 59A. Proposed § 1.59A-1(b)(17) provides a definition of the term “related party.” The proposed regulations generally define a related party with respect to an applicable taxpayer as (a) any 25-percent owner of the taxpayer, (b) any person related (within the meaning of section 267(b) or 707(b)(1)) to the taxpayer or any 25-percent owner of the taxpayer, or (c) a controlled taxpayer within the meaning of § 1.482-1(i)(5).

The proposed regulations' definition of “related party” is identical to the definition provided by section 59A(g), except with respect to the relatedness standard under section 482. Specifically, the proposed regulations provide a more precise citation to the section 482 regulations (“a controlled taxpayer within the meaning of § 1.482-1(i)(5)”) than the general cross-reference that is provided in section 59A(g)(1)(C) (“any other person who is related (within the meaning of section 482) to the taxpayer”).

Comments recommended that the final regulations modify the definition of “related party” to exclude related publicly traded companies or otherwise provide an exception for payments between publicly traded companies. These comments suggested that payments between related publicly traded companies do not result in base erosion. The comments explained that the boards of directors of publicly traded companies generally have fiduciary obligations to shareholders to act in the best interest of the company and are subject to regulatory oversight. On this basis, the comments asserted that a domestic corporation cannot artificially shift profits to a foreign corporation in this situation. Comments also noted that the Treasury Department and the IRS have provided relief for publicly traded companies in circumstances where there is no explicit legislative history or statutory authority to do so, such as where minority shareholders of publicly traded companies must be identified.

See

§ 1.367(e)-1(d)(3) and § 1.382-2T(j).

The Treasury Department and the IRS have determined that it is not appropriate to modify the statutory definition of a related party to exclude publicly traded companies because this recommendation is inconsistent with the statutory language of section 59A(g). Section 59A(g) sets forth specific limits on the definition of a “related party” that include a corporation and its 25-percent owner. Under the proposal recommended by the comments, section 59A would not apply to any less than 100 percent owned affiliate, so long as other “public” shareholders owned some interest in the corporation. The corporate laws of a state of the United States or a foreign jurisdiction may, and often do, impose certain duties on the board of directors of a company, including obligations with respect to the interests of minority shareholders. These companies are also subject to securities laws in the United States. Notwithstanding this regulatory environment, the Code includes many provisions that apply to related parties, and none of those provisions are limited to corporations that are 100 percent related.

For example, section 267(a) generally applies to transactions among greater than 50 percent controlled parties. Section 482 provides a test that can be satisfied by a quantitative measure of ownership or a qualitative test of control (“two or more organizations, trades, or businesses . . . owned or controlled directly or indirectly by the same interests”), that, as interpreted by regulations, can apply at well below a 100 percent relatedness standard.

See

§ 1.482-1(i)(5). Other sections of the

Code apply based on a relatedness standard of 80 percent.

See, generally,

section 1504; section 351(a). In section 59A, Congress adopted, disjunctively, both the 50 percent relatedness-test from section 267(a) and the relatedness-test from section 482. Moreover, Congress also added, disjunctively, a lower objective standard for determining relatedness for a 25-percent owner.

Finally, the Treasury Department and IRS concluded that a rule that confers special status on payments to a publicly traded foreign corporation that is related (using a 25 percent or greater standard) to the payor would not be analogous to the rules in § 1.367(e)-1(d)(3) or § 1.382-2T(j), which provide special rules that pertain to shareholders that own less than 5 percent of publicly traded corporations, in light of challenges in determining the identity of such shareholders.

For these reasons, the final regulations do not modify the relatedness thresholds that are set forth in section 59A and the proposed regulations.

III. Comments and Changes to Proposed § 1.59A-2—Applicable Taxpayer, Aggregation Rules, Gross Receipts Test, and Base Erosion Percentage Test

Proposed § 1.59A-2 contains rules for determining whether a taxpayer is an applicable taxpayer on which the BEAT may be imposed, including rules relating to the gross receipts test, base erosion percentage test, and the determination of the aggregate group for purposes of applying these tests.

A. Determining the Gross Receipts and Base Erosion Percentage of an Aggregate Group That Includes a RIC, a REIT, or an Entity Treated as a Corporation by Section 892

Section 59A(e)(1)(A) excludes corporations that are (1) regulated investment companies (“RICs”), (2) real estate investment trusts (“REITs”), or (3) S corporations from the definition of an applicable taxpayer. A comment requested that the final regulations clarify that controlled RICs and REITs are similarly excluded from the aggregate group for purposes of the gross receipts test and base erosion percentage test. The comment implied that the Treasury Department and the IRS did not intend for RICs and REITs to be part of an aggregate group because RICs and REITs are not subject to the BEAT as separate taxpayers. The proposed regulations do not exclude RICs and REITs from membership in an aggregate group. A corporation is an applicable taxpayer if it is not one of the excluded categories of corporations (RIC, REIT, or S corporation), it satisfies the gross receipts test in section 59A(e)(1)(B), and it satisfies the base erosion percentage test in section 59A(e)(1)(C). The proposed regulations provide that when applying the gross receipts test and the base erosion percentage test with respect to a particular corporation for purposes of section 59A, those tests are applied on the basis of that corporation and members of that corporation's aggregate group. The proposed regulations define an aggregate group by reference to section 1563(a) in a manner consistent with section 59A(e)(3), which references section 1563(a) indirectly. The section 1563(a) definition refers to controlled groups of corporations, whether brother-sister groups or parent-subsidiary groups. Section 1563(c) provides special rules excluding certain categories of stock in a corporation from the aggregation rules in section 1563(a) (for example, certain stock held by an organization to which section 501 applies). None of those provisions exclude the stock of, or held by, a RIC or REIT. Moreover, just as the gross receipts and deductions of non-applicable taxpayers (such as partnerships) can inure to the benefit of an applicable taxpayer (such as a domestic corporation that is a partner in a partnership), so too can the gross receipts and deductions of a controlled RIC or REIT that is a member of a corporation's aggregate group inure to the benefit of that corporation. Because of these considerations, the final regulations do not adopt this recommendation.

Similarly, another comment requested that the final regulations exclude from the aggregate group foreign government owners of stock of corporations when the foreign government is treated as a corporation under section 892 and the regulations thereunder. The comment cited the exclusion from section 1563(a) of certain stock held by an organization to which section 501 applies, and suggested that a foreign government should be provided similar treatment because a foreign government, like a section 501 organization, does not have private shareholders. In addition, the comment asserted that it cannot be engaged in direct commercial activities with respect to its portfolio companies and that its investment managers consist of separate teams.

The Treasury Department and the IRS have determined that it is not appropriate to provide a regulatory exception from the aggregate group rules for entities that are commonly controlled by a foreign government shareholder and that are treated as corporations under section 892. Congress provided that the activities of an aggregate group are fully taken into account when applying the gross receipts test and the base erosion percentage test to a corporation. The fact that a common shareholder of a different chain of corporations may be more passive than other common shareholders, or that the common shareholder's investment teams are within different lines of a management structure does not change the fact the common shareholder has economic interests in the subsidiary corporation that is within the statutory aggregate group definition adopted for section 59A. Accordingly, the final regulations do not adopt this recommendation.

B. Gross Receipts From Certain Inventory and Similar Transactions

To determine gross receipts, section 59A(e)(2)(B) provides for “rules similar to the rules” of section 448(c)(3)(B), (C), and (D). Accordingly, these final regulations provide rules that are similar to, but not necessarily the same as, the rules of section 448(c)(3) and the implementing regulations. Proposed § 1.59A-1(b)(13) defines the term “gross receipts” for purposes of section 59A by reference to § 1.448-1T(f)(2)(iv), which provides that gross receipts include total sales, net of returns and allowances, and all amounts received for services. Section 1.448-1T(f)(2)(iv) further provides that gross receipts are not reduced by cost of goods sold (“COGS”) or reduced by the cost of property sold if such property is described in section 1221(a)(1), (3), (4), or (5) (types of property excluded from the definition of a capital asset). Separately, § 1.448-1T(f)(2)(iv) provides that gross receipts from the sale of capital assets or a sale of property described in section 1221(a)(2) (relating to property used in a trade or business) are reduced by the adjusted basis of the property sold. Section 1.448-1T(f)(2)(iv) further provides that gross receipts include income from investments, but not the repayment of a loan or similar instrument.

Comments observed that, pursuant to the definition of gross receipts in the proposed regulations, banks that originate and then sell loans are required to include the gross proceeds from the sale of the loan in their gross receipts because banks generally treat loans originated in the ordinary course of business as ordinary assets under section 1221(a)(4). These comments contrasted a situation where a bank originates and holds a loan to maturity, in which case the proceeds the bank receives upon repayment are not

included in gross receipts due to the express exclusion of these amounts contained in § 1.448-1T(f)(2)(iv). The comments recommended that the regulations provide for a separate reduction of gross receipts from the sale of a loan for the basis in loans originated by a bank. Another comment recommended a similar exception for a bank or broker-dealer that holds stocks and bonds in inventory. This comment proposed that final regulations permit banks and broker-dealers to reduce gross receipts from ordinary course sales of stocks and bonds by the basis of these instruments. The comment also observed that the gains or losses recognized with respect to the stocks and bonds are from sales in the ordinary course and may be small relative to the cost basis in the property.

The final regulations do not adopt the approach suggested by these comments. The final regulations continue to define the term “gross receipts” by cross-referencing to § 1.448-1T(f)(2)(iv), and those rules are used to determine how an item is included in gross receipts. The rules in section 59A for implementing the gross receipts test are similar to the rules described in section 448(c).

See

section 59A(e)(3) (adopting an aggregation rule similar to that in section 448(c)(2)); section 59A(e)(2)(B) (specifically cross-referencing rules similar to section 448(c)(3)(B), (C), and (D) for the treatment of short taxable years, reductions for returns and allowances, and predecessors, respectively); and section 59A(e)(2)(A) (adopting a broad concept of gross receipts, narrowed to exclude gross receipts of a foreign person that are not taken into account in determining income that is effectively connected with the conduct of a trade or business within the United States). Because of this statutory link between section 59A(e)(2) and section 448, the final regulations adopt the definition of gross receipts for purposes of section 59A that is used for section 448 purposes—that is, the definition in § 1.448-1T(f)(2)(iv). Because the Act includes other new rules that cross-reference section 448, the Treasury Department and the IRS are studying section 448 generally and whether changes should be made to the regulations under section 448 to take into account the Act.

C. Determining the Aggregate Group for Purposes of Applying the Gross Receipts Test and Base Erosion Percentage Test

Section 59A determines the status of a corporation as an applicable taxpayer on the basis of the aggregate group rules by taking into account the gross receipts and base erosion payments of each member of the aggregate group. However, each taxpayer must compute the amount of gross receipts and base erosion payments for its aggregate group using its own taxable year and based on those corporations that are members of the aggregate group at the end of the taxable year.

See

section 59(e)(3). Therefore, members with different taxable years may have different base erosion percentages.

1. Members of an Aggregate Group With Different Taxable Years

The proposed regulations provide rules for determining whether the gross receipts test and base erosion percentage test are satisfied for purposes of section 59A with respect to a specific taxpayer when other members of its aggregate group have different taxable years.

See

proposed § 1.59A-2(e)(3)(vii). In general, the proposed regulations provide that, for purposes of section 59A only, each taxpayer determines its gross receipts and base erosion percentage by reference to its own taxable year, taking into account the results of other members of its aggregate group during that taxable year. In other words, the gross receipts, base erosion tax benefits, and deductions of the aggregate group for a taxable year are determined by reference to the taxpayer's own taxable year, without regard to the taxable year of the other member. This rule applies regardless of whether the taxable year of the member begins before January 1, 2018; as a result, a taxpayer includes gross receipts, base erosion tax benefits, and deductions of the member even if that member is not subject to section 59A for that taxable year. The proposed regulations adopted this approach to reduce compliance burden through providing certainty for taxpayers and avoid the complexity of a rule that identifies a single taxable year for an aggregate group for purposes of section 59A that may differ from a particular member of the aggregate group's taxable year. As a result, under the proposed regulations, two related taxpayers with different taxable years may compute their respective gross receipts and base erosion percentages for purposes of section 59A by reference to different periods, even though each taxpayer calculates these amounts on an aggregate group basis that takes into account other members of the controlled group. The preamble to the proposed regulations explains that taxpayers may use a reasonable method to determine the gross receipts and base erosion percentage information with regard to the taxable year of the taxpayer when members of the aggregate group of the taxpayer have a different taxable year. REG-104259-18, 83 FR 65956, 65959 (December 21, 2018).

Comments expressed concern regarding the potential administrative burdens of treating all members of a taxpayer's aggregate group as having the same taxable year as the taxpayer. These comments argued that, in many cases, companies do not maintain monthly accounting records as detailed as they do on a quarterly basis (for publicly traded companies) or an annual basis (for privately held companies). Also, comments noted that this rule does not take into account the effect of deductions that are determined on a yearly basis or subject to annual limitations, such as under section 163(j).

Comments requested that the determination of gross receipts and the base erosion percentage of a taxpayer's aggregate group be made on the basis of the taxpayer's taxable year and the taxable year of each member of its aggregate group that ends with or within the applicable taxpayer's taxable year (the “with-or-within method”). With respect to members of an aggregate group with different taxable years, the Treasury Department and the IRS appreciate the concerns raised regarding the potential administrative burden of proposed § 1.59A-2(e)(3)(vii) and believe that the approach described in the comments represents a reasonable approach. The final regulations, therefore, adopt the with-or-within method, for purposes of section 59A only, to determine the gross receipts and the base erosion percentage of an aggregate group.

See

§ 1.59A-2(c)(3). In addition, the Treasury Department and the IRS are issuing a notice of proposed rulemaking (the “2019 proposed regulations”) published in the same issue of the

Federal Register

as these final regulations that proposes rules to further address how to implement the with-or-within method, and how to take into account the changing composition of the aggregate group with respect to a particular taxpayer during the relevant periods for applying the gross receipts test and the base erosion percentage test. The final regulations do not include rules on predecessors or short taxable years. Instead, rules relating to these situations have been re-proposed in the 2019 proposed regulations. Until final rules are applicable relating to predecessors or short taxable years, taxpayers must take a reasonable approach consistent with section 59A(e)(2)(B) to determine gross receipts and base erosion benefits in these situations.

2. Time for Determining That Transactions Occurred Between Members of the Aggregate Group

The proposed regulations provide that, for purposes of section 59A, transactions that occur between members of the aggregate group that were members of the aggregate group at the time of the transaction are not taken into account for purposes of determining the gross receipts and base erosion percentage of an aggregate group.

See

proposed § 1.59A-2(c). In the case of a foreign corporation that is a member of an aggregate group, only transactions that relate to income effectively connected with the conduct of a trade or business in the United States are disregarded for this purpose. The preamble to the proposed regulations explains that this limitation on the extent to which foreign corporations are included in the aggregate group is intended to prevent payments from a domestic corporation, or a foreign corporation with respect to effectively connected income, to a foreign related person, from being inappropriately excluded from the base erosion percentage test. REG-104259-18, 83 FR 65956, 65957 (December 21, 2018).

A comment requested clarity on determining whether transactions between members of an aggregate group are disregarded. Specifically, the comment requested clarity on whether a transaction is disregarded when both parties to the transaction are members of the aggregate group at the time of the transaction, or whether it is also a condition that both parties to the transaction must also be members of the aggregate group on the last day of the taxpayer's taxable year.

As requested by the comment, the final regulations clarify that a transaction between parties is disregarded for purposes of section 59A when determining the gross receipts and base erosion percentage of an aggregate group if both parties were members of the aggregate group at the time of the transaction, without regard to whether the parties were members of the aggregate group on the last day of the taxpayer's taxable year.

See

§ 1.59A-2(c)(1).

3. Base Erosion Tax Benefits and Deductions of a Member of an Aggregate Group With a Taxable Year Beginning Before January 1, 2018

For purposes of determining the base erosion percentage, comments also expressed concern about including the base erosion tax benefits and deductions of a member when the taxable year of the member begins before January 1, 2018. The comments noted that this taxable year of the member is not otherwise subject to section 59A because of the effective date in section 14401(e) of the Act. However, one comment agreed with including these base erosion tax benefits and deductions in the aggregate group of a taxpayer for a taxable year of the taxpayer to which section 59A applies.

The Treasury Department and the IRS agree with comments that it is not appropriate for a taxpayer to include base erosion tax benefits and deductions attributable to a taxable year of a member of its aggregate group that begins before the effective date of section 59A when determining the base erosion percentage of the aggregate group. Accordingly, when determining the base erosion percentage of an aggregate group, the final regulations exclude the base erosion tax benefits and deductions attributable to the taxable year of a member of the aggregate group that begins before January 1, 2018.

See

§ 1.59A-2(c)(8). This rule avoids requiring members of an aggregate group to calculate their hypothetical base erosion tax benefits for a year in which the base erosion tax benefit rules do not apply.

4. Other Comments Regarding the Aggregate Group Rules

Comments also addressed the following issues with respect to the aggregate group rules in the proposed regulations: (1) How to take into account transactions when a member joins or leaves an aggregate group, (2) the treatment of predecessors of a taxpayer, (3) the determination of the aggregate group of a consolidated group, and (4) the treatment of short taxable years. The Treasury Department and the IRS continue to study the recommendations provided in several comments relating to these issues. Therefore, the Treasury Department and the IRS are issuing the 2019 proposed regulations to further address aggregate group issues.

D. Mark-to-Market Deductions

To determine the base erosion percentage for the year, the taxpayer (or in the case of a taxpayer that is a member of an aggregate group, the aggregate group) must determine the amount of base erosion tax benefits in the numerator and the total amount of certain deductions, including base erosion tax benefits, in the denominator. The proposed regulations provide rules for determining the total amount of the deductions that are included in the denominator of the base erosion percentage computation in the case of transactions that are marked to market. In determining the amount of the deduction that is used for purposes of the base erosion percentage test, the proposed regulations require the combination of all items of income, deduction, gain, or loss on each marked transaction for the year (“the BEAT Netting Rule”), such as from a payment, accrual, or mark.

See

proposed § 1.59A-2(e)(3)(vi). The BEAT Netting Rule was adopted to ensure that only a single deduction is claimed with respect to each marked transaction and to prevent distortions in deductions from being included in the denominator of the base erosion percentage, including as a result of the use of an accounting method that values a position more frequently than annually.

A comment requested guidance clarifying whether the BEAT Netting Rule applies to physical securities such as stocks, bonds, repurchase agreements, and securities loans with respect to which a taxpayer applies a mark-to-market method of accounting. The comment questioned whether the BEAT Netting Rule should apply to these types of positions. The comment acknowledged that the BEAT Netting Rule produces an appropriate result with respect to derivatives by avoiding double-counting of both a current mark-to-market loss as well as a future payment to which the current loss relates. Unlike in the case of many derivatives, the comment observed that transactions involving stocks, bonds, repurchase agreements, and securities loans generally do not result in a loss of value to the holder of the relevant instrument that is subsequently realized in the form of a payment made by the holder and that effectively gives rise to an offsetting mark-up of the instrument.

To illustrate this observation, the comment provided the following example. On January 1, 2018, a dealer buys one share of stock in Company XYZ for $100. Then, during 2018, Company XYZ pays dividends of $1 with respect to the share. On December 31, 2018, the share price of Company XYZ is $90. Finally, on January 1, 2019, the dealer sells the share of Company XYZ stock for $90. The comment noted that in the absence of the BEAT Netting Rule, the amount of the dealer's deduction after marking the stock to market on December 31, 2018, would be $10. With the application of the BEAT Netting Rule, however, the comment noted that the amount of the deduction that will be included in the base erosion percentage denominator is $9. According to this comment, the BEAT Netting Rule may not be necessary to avoid the double-counting of deductions

in these transactions, and could result in the netting of amounts that would not be netted under section 475 and that are not duplicative of other inclusions or deductions by the taxpayer.

Proposed § 1.59A-2(e)(3)(vi) applies to any position with respect to which the taxpayer (or in the case of a taxpayer that is a member of an aggregate group, a member of the aggregate group) applies a mark-to-market method of accounting. Therefore, the BEAT Netting Rule in the proposed regulations applies to stocks, bonds, repurchase agreements, and securities lending transactions that the taxpayer marks to market, rendering further clarification unnecessary. The Treasury Department and the IRS have determined that the applicability of the BEAT Netting Rule should not be limited in the manner suggested by the comment. In addition to avoiding the double counting that the comment acknowledged, the proposed regulations adopt the BEAT Netting Rule to enhance administrability and reduce compliance burden. That is, having a single rule apply to all transactions that are marked to market will enhance administrability, especially given the challenges in (a) distinguishing the specific financial transactions that should qualify for exclusion; (b) determining whether a distribution or payment received on an excluded instrument is duplicative of other inclusions or deductions; and (c) determining the extent to which a payment ultimately gives rise to an offsetting decline in the value of the instrument. For these reasons, the BEAT Netting Rule in the final regulations does not exclude physical securities.

Another comment recommended that the BEAT Netting Rule should not be mandatory and should instead be included in the final regulations as only a safe harbor. The comment reasoned that section 59A is generally applied on a gross basis and that requiring taxpayers to offset deductions and losses with income and gain when determining the base erosion percentage is inconsistent with a gross approach. The BEAT Netting Rule was adopted to ensure that taxpayers do not overstate the amount of deductions includible in the denominator with respect to transactions subject to a mark-to-market method of accounting. If the BEAT Netting Rule were provided as a safe harbor in the final regulations, as this comment requested, taxpayers could inappropriately inflate the denominator of the base erosion percentage by treating multiple marks as separate deductions. Therefore, the final regulations do not adopt this comment.

As discussed in Part III.D of this Summary of Comments and Explanation of Revisions, the taxpayer must also determine the amount of base erosion tax benefits in the numerator to determine the base erosion percentage for the year. Proposed § 1.59A-3(b)(2)(iii) also applies the BEAT Netting Rule for purposes of determining the amount of base erosion payments that result from transactions that are marked to market. A comment expressed concern that this rule could result in mark-to-market losses being treated as base erosion payments and recommended the withdrawal of proposed § 1.59A-3(b)(2)(iii), although the comment observed that if the Treasury Department and the IRS were to adopt the comment to make the qualified derivative payments (“QDP”) exception available to securities loans (which is discussed in Part VII of this Summary of Comments and Explanation of Revisions), that change would make this issue moot. The Treasury Department and the IRS do not view this concern to be valid, considering that a mark-to-market loss arising from a deemed sale or disposition of a third-party security held by a taxpayer is not within the general definition of a base erosion payment because the loss is not attributable to any payment made to a foreign related party. Rather, the mark-to-market loss is attributable to a decline in the market value of the security. The Treasury Department and the IRS also note that the BEAT Netting Rule will apply primarily for purposes of determining the amount of deductions that are taken into account in the denominator of the base erosion percentage. The Treasury Department and the IRS agree with the comment that the QDP exception of § 1.59A-3(b)(3)(ii) eliminates most mark-to-market transactions from characterization as a base erosion payment, including as a result of the expansion of the QDP exception to apply to the securities leg of a securities loan. See Part VII of this Summary of Comments and Explanation of Revisions for a discussion of the qualification of the securities leg of a securities loan for the QDP exception. Thus, the BEAT Netting Rule will apply only in limited circumstances such as when the taxpayer fails to properly report a QDP. The final regulations therefore continue to apply the BEAT Netting Rule for purposes of determining the amount of base erosion payments that result from transactions that are marked to market.

IV. Comments and Changes to Proposed § 1.59A-3—Base Erosion Payments and Base Erosion Tax Benefits

Proposed § 1.59A-3 contains rules for determining whether a payment or accrual gives rise to a base erosion payment and the base erosion tax benefits that arise from base erosion payments.

A. How Base Erosion Payments Are Determined in General

Proposed § 1.59A-3(b)(1) defines a base erosion payment as a payment or accrual by the taxpayer to a foreign related party that is described in one of four categories: (1) A payment with respect to which a deduction is allowable; (2) a payment made in connection with the acquisition of depreciable or amortizable property; (3) premiums or other consideration paid or accrued for reinsurance that is taken into account under section 803(a)(1)(B) or 832(b)(4)(A); or (4) a payment resulting in a reduction of the gross receipts of the taxpayer that is with respect to certain surrogate foreign corporations or related foreign persons.

The Conference Report to the Act states that base erosion payments do not include any amounts that constitute reductions to determine gross income including payments for COGS (except for reductions to determine gross income for certain surrogate foreign corporations). Conf. Rep. at 657. The proposed regulations do not contain a provision that expressly provides that amounts paid or accrued to a related foreign person that result in reductions to determine gross income are not treated as base erosion payments (except in the case of certain surrogate foreign corporations). A comment requested that, in order to provide more certainty to taxpayers, the final regulations expressly reflect that payments that result in reductions to determine gross income are not subject to section 59A. In response to this comment, § 1.59A-3(b) has been modified to explicitly clarify that payments resulting in a reduction to determine gross income, including COGS, are not treated as base erosion payments within the meaning of section 59A(d)(1) or (2).

See

§ 1.59A-3(b)(2)(viii).

The proposed regulations do not establish any specific rules for determining whether a payment is treated as a deductible payment. However, the preamble to the proposed regulations states that, except as otherwise provided in the proposed regulations, the determination of whether a payment or accrual by the taxpayer to a foreign related party is

described in one of the four categories is made under general U.S. federal income tax law. REG-104259-18, 83 FR 65956, 65959 (December 21, 2018). The preamble to the proposed regulations refers specifically to agency principles, reimbursement doctrine, case law conduit principles, and assignment of income as examples of principles of generally applicable tax law.

Id.

A comment noted the potential for ambiguity that could result by failing to reflect in the text of the proposed regulations the language contained in the preamble to the proposed regulations and requested that the final regulations provide more specific guidance on how the determination of whether a payment is a base erosion payment is made. In response to this comment, the final regulations include in the regulatory text a rule that the determination of whether a payment or accrual is a base erosion payment is made under general U.S. federal income tax law.

See

§ 1.59A-3(b)(2)(i).

Similarly, because existing tax law generally applies, the amounts of income and deduction for purposes of section 59A are generally determined on a gross basis under the Code and regulations. The proposed regulations generally do not permit netting of income and expense in determining amounts of base erosion payments. Comments to the proposed regulations requested guidance regarding (1) transactions involving a middle-man or a passthrough payment, (2) divisions of revenues in connection with global service arrangements, and (3) the general netting of income and expense.

1. Transactions Involving a “Middle-Man” or “Passthrough Payments”

Several comments requested additional guidance relating to transactions or arrangements in which a taxpayer serves as a so-called middle-man for a payment to a foreign related party or makes a so-called passthrough payment to a foreign related party that may frequently arise in connection with global services and similar businesses. Broadly, the comments considered situations where a domestic corporation makes a deductible payment to a foreign related party, and that foreign related party in turn makes corresponding payments to unrelated third parties. Comments that addressed this concern arose in a variety of industries and business models. In some situations, the comments observed that business exigencies require the domestic corporation to make payments to the foreign related party. For example, in a business involving the physical delivery of goods within a foreign jurisdiction, a domestic corporation may subcontract with its foreign related party to perform the foreign in-country delivery function. Another example involves global service contracts that may be entered into by a domestic corporation and a client that does business in multiple jurisdictions, and may require services in connection with the client's global operations that are also subcontracted to foreign related parties. Some more specific comments observed that this global services situation may arise in connection with U.S.-based manufacturers that sell manufactured products to unrelated global customers and simultaneously enter into contracts to provide services for the product in multiple jurisdictions in connection with the sale of equipment. The comments observed that these service contracts, like other global services contracts, frequently involve subcontracting with a foreign related party to perform the services in foreign jurisdictions.

Multiple comments requested that the final regulations provide that the definition of a base erosion payment does not include payments made pursuant to a contract when a taxpayer makes a corresponding payment to a foreign related party for third party costs. Other comments requested that the final regulations more specifically exempt the types of business models discussed in the comment letters. For example, some comments recommended that the final regulations provide an exception to the term “base erosion payment” for payments made by a taxpayer to a foreign related party with respect to services performed for an unrelated party, provided that the foreign related party performs the services outside of the United States. Other comments recommended a similar exception that would apply only to services that are performed in connection with tangible property produced or manufactured by the taxpayer (or a related party). These comments observed that Congress intended to exclude manufacturers from the BEAT because it effectively created an exception for COGS, and that this exception should be carried through to services in connection with manufacturing.

Other comments recommended an exception to the definition of base erosion payment for payments to foreign related parties that are mandated under regulatory requirements. In other situations, comments observed that regulatory considerations affect the decision by the domestic corporation to make a payment to the foreign related party. An example includes a global dealing operation where a U.S. securities dealer has a client who wants to trade its securities on a foreign securities exchange that requires a locally registered dealer; for those trades, a foreign related party of the U.S. securities dealer conducts those trades. Other examples involving regulatory considerations include U.S. life sciences companies that, in connection with obtaining food and drug approval to sell a product in a foreign market, use a foreign related party to conduct clinical trials in that market because foreign regulators require testing on local patients.

The final regulations do not adopt a general exception to the definition of a base erosion payment in situations when the foreign related payee also makes payments to unrelated persons. The BEAT statute and the legislative history contain no indication of such an exception. Moreover, this recommended exception is inconsistent with the statutory framework of the BEAT. If traced to the ultimate recipient, most expenses of a taxpayer could be linked to a payment to an unrelated party, through direct tracing or otherwise, leaving a residual of profit associated with the payment. Accordingly, adopting such an exception would have the effect of eliminating a significant portion of service payments to foreign related parties from the BEAT because it would impose the BEAT on the net rather than the gross amount of the payment. The only net income based concept included in the BEAT statute is the treatment of payments covered by the services cost method (“SCM”) exception. For a further discussion of the SCM exception, see Part IV.C.1 of this Summary of Comments and Explanation of Revisions.

The final regulations also do not adopt a narrower regulatory exception for payments that arise in similar circumstances but that are also associated with manufacturing or the production of tangible property. The Treasury Department and the IRS do not view the presence or absence of manufacturing as bearing on the statutory definition of a base erosion payment for services. Further, the Treasury Department and the IRS do not view the fact that payments that reduce gross receipts, such as COGS, are not base erosion payments under section 59A(d)(1) as demonstrating Congressional intent to exclude services that do not qualify as COGS from the definition of a base erosion payment under section 59A(d)(1) if those services have a connection to manufacturing operations. Congress included a single specific exception for services—the SCM exception. For a further discussion

of that exception, see Part IV.C.1 of this Summary of Comments and Explanation of Revisions.

The final regulations do not adopt a narrower exception for payments to foreign related parties that arise because of non-tax business considerations, including a non-tax foreign regulatory requirement. The Treasury Department and the IRS recognize that there may be non-tax reasons that compel a taxpayer to perform a particular global service outside the United States. For example, an international delivery service may need to engage a foreign related party in the destination country to deliver goods in a foreign jurisdiction.

The final regulations do not adopt this recommended exception because it would require rules to distinguish between the conditions under which a domestic corporation is compelled to operate through a foreign related party and the conditions under which a domestic corporation operates through a foreign related party as a result of a business choice. This distinction would be inherently subjective. For example, in a global service business that provides services to a global client that has operations around the world, the decision to provide personnel on-site in a foreign location may or may not be compelled by the business needs of its client. Similarly, in the case of the back-office functions of a global services business, those functions may be performed in the United States or in a location outside of the United States; the location of those services may or may not be compelled by the business needs of their client. Moreover, even if there is a compelling reason to operate the activities outside the United States, a base erosion payment exists only if a taxpayer makes a payment to a foreign related party. Thus, if a foreign branch of the domestic corporation performs services in the foreign jurisdiction, there will be no payment or accrual to a foreign related party. Finally, there is no indication that Congress intended to create a broad services exception, outside of the SCM exception, even though these global services conditions are common in the modern economy.

2. Division of Revenues From Global Services

Comments requested that final regulations provide an exception from the term “base erosion payment” for revenue sharing payments or arrangements, including allocations with respect to global dealing operations. Specifically, some comments recommended that the final regulations provide that a payment is not a base erosion payment in a situation where the domestic corporation records revenue from transactions with third party customers, and in turn the domestic corporation makes payments to a foreign related party. Other comments recommended that payments by the domestic corporation to foreign related parties should not be base erosion payments if the parties have adopted a profit split as their best method of pricing the related-party transactions for purposes of section 482. Some of these comments asserted that parties to such payments could be viewed as splitting the customer revenue for purposes of section 59A. Under this view, the payments received by the foreign related party would be treated as received directly from the third-party customer, with the result that there would be no corresponding deductible payment from the domestic corporation to the foreign related party.

Other comments more specifically addressed this issue in the narrower context of a global dealing operation within the meaning of proposed § 1.482-8(a)(2)(i). These comments requested that payments made pursuant to a global dealing operation not be treated as base erosion payments.

The final regulations do not adopt the recommendations to specifically exclude from the definition of a base erosion payment transactions that are priced based on the profit split or similar transfer pricing method that is used for purposes of section 482. Under section 482, the parties to a controlled transaction apply the best method to determine if the parties are compensated at arm's length. However, the use of a particular method, whether the profit split method or another method, does not change the contractual relationship between the parties. Accordingly, the final regulations do not adopt this recommendation because the proper characterization depends on the underlying facts and the relationships between the parties.

See

§ 1.59A-3(b)(2).

Similarly, with respect to a global dealing operation, the final regulations do not adopt the comment to provide that global dealing operations do not give rise to base erosion payments because the proper characterization depends on the underlying facts. Under general tax principles, and consistent with proposed § 1.863-3(h), a global dealing operation in which participants manage a single book of assets, bear risk, and share in trading profits may be viewed as co-ownership of the trading positions or similar arrangement, with no deductible payments made by any participants for purposes of section 59A. In contrast, where non-U.S. participants are compensated for services performed, the arrangement may be more properly characterized as trading income to the U.S. participant and a deductible payment to the foreign participant for purposes of section 59A.

To the extent that an amount is treated under general U.S. federal income tax law as received by a U.S. person as an agent for, and is remitted to, a foreign related party, see also Part IV.A (How Base Erosion Payments are Determined in General) of this Summary of Comments and Explanation of Revisions, which discusses the addition of § 1.59A-3(b)(2)(i) to clarify that the determination of whether a payment or accrual by the taxpayer to a foreign related party is described in one of four categories of a base erosion payment is made under general U.S. federal income tax law, including agency principles.

3. Netting of Income and Expense

Proposed § 1.59A-3(b)(ii) generally states that the amount of any base erosion payment is determined on a gross basis, regardless of any contractual or legal right to make or receive payments on a net basis, except as otherwise provided in paragraph (b)(2)(iii) of that section, which addresses mark-to-market positions, or as permitted by the Code or regulations. As explained in the preamble to the proposed regulations, the BEAT statutory framework is based on including the gross amount of base erosion payments in the BEAT's expanded modified taxable income base. REG-104259-18, 83 FR 65956, 65968 (December 21, 2018).

a. In General

Numerous comments recommended that the final regulations permit netting for purposes of section 59A. Generally, netting would allow a taxpayer to determine the amount of a base erosion payment by reducing the amount of that payment by the amount of another corresponding obligation.

A comment asserted that netting should be permitted for all base erosion payments other than with respect to reinsurance payments. The comment explained that the plain language of section 59A(d)(1) provides that only amounts paid or accrued are taken into account; this comment interpreted this language to mean the net amount paid or accrued. Because section 59A(d)(3) refers to gross premiums in the reinsurance context, the comment maintained that netting is permitted for other base erosion payments. This comment also noted that netting was provided under proposed section 4491, an inbound base erosion provision

included in section 4303 of the House version of H.R. 1, before the Senate amended H.R.1 to include the BEAT in place of proposed section 4491. This comment also recommended that netting be permitted because other sections of the Code or regulations include netting concepts, such as sections 163(j), 250 and 951A, and the aggregation rule in § 1.482-1T(f)(2)(i)(B).

Some comments recommended that the final regulations permit netting when the foreign related party payee has a corresponding obligation to make payments to an unrelated third party payee. Some of these comments asserted that base erosion payments arise because of commercial and regulatory efficiency and expediency, rather than because of tax planning. These comments recommended that netting be permitted in ordinary course transactions. Other comments recommended that the final regulations permit netting for deductible amounts owed by a domestic corporation to a foreign related party if the foreign related party also owes amounts to the domestic corporation and the obligations are settled on a net basis.

The Treasury Department and the IRS have determined that it is appropriate to retain the approach in the proposed regulations that the amount of a base erosion payment is determined on a gross basis, except as provided in the BEAT Netting Rule and to the extent permitted by the Code or regulations. See part III.D of this Summary of Comments and Explanation of Revisions (Mark-to-market deductions). As explained in the preamble to the proposed regulations, amounts of income and deduction are generally determined on a gross basis under the Code. REG-104259-18, 83 FR 65956, 65968 (December 21, 2018). For example, whether the amount of income or deductions with respect to financial contracts that provide for offsetting payments is taken into account on a gross or net basis is determined under generally applicable federal income tax law. Section 59A does not change that result.

The final regulations are consistent with the statutory framework of section 59A. Section 59A specifically addresses deductible payments and other statutorily defined base erosion payments, and imposes tax on an increased base of modified taxable income, but at a lower tax rate than the corporate income tax rate set forth in section 11. If regulations provided that statutorily defined base erosion payments could be reduced by offsetting amounts received, then the regulations would substantially limit the scope of section 59A. Section 11 imposes a tax on a corporation's taxable income. Taxable income is defined as gross income minus the deductions allowed by chapter 1 of the Code. Section 63. Gross income is generally defined as income from whatever source derived. Section 61. The amount of income and deductions are generally determined on a gross basis under the Code. Nothing in section 59A evidences Congressional intent to alter this framework. In fact, section 59A(c) determines modified taxable income from the starting point of taxable income as defined in section 63.

A netting rule would have the same effect as allowing a deduction from gross income because it would reduce the amount of a taxpayer's modified taxable income, and in that sense would conflict with section 59A(c)(1) (disallowing a deduction for base erosion tax benefits). Congress determined that certain deductions, namely those that are within the statutory definition of a base erosion payment, should not be allowed for purposes of the tax imposed under section 59A, and therefore, limited the availability of these deductions. Permitting netting of items of gross income and deductions to determine the amount of a base erosion payment would frustrate Congress' purpose in enacting section 59A.

In addition, the other provisions of the Code and regulations that are cited by comments are irrelevant to the analysis of section 59A and do not provide support for adopting a netting rule for purposes of section 59A. Whereas sections 163(j) and 951A refer explicitly to net amounts, section 59A explicitly refers to a deduction allowable under Chapter 1 of the Code. Section 250 provides rules for determining whether services are for “foreign use” by contemplating services provided to and from a related party that are substantially similar. This destination-based rule is entirely different from the construct of section 59A, and, moreover, section 59A contains no similar language contemplating payments to and from a related party. Proposed section 4491 would have operated through the regular income tax system and would have represented a fundamentally different approach to inbound base erosion than section 59A; therefore, that proposed revision to the Code is not relevant here. The aggregation rule in § 1.482-1T(f)(2)(i)(B) does not involve the treatment of payments to foreign related parties, and thus is not relevant for purposes of analyzing the meaning of section 59A.

Some comments also cited the heading to section 59A(h) (exception for certain payments made in the ordinary course of trade or business) as support for a regulatory exception for ordinary course transactions for which a taxpayer has not adopted a mark-to-market method of accounting. Specifically, these comments suggested that Congress did not intend for section 59A(h)(2)(A)(i) to limit the QDP exception to only transactions that are marked-to-market. The citations to the heading to section 59A(h) are inconsistent with the statutory rule in section 59A(h), which provides a narrowly defined exception applicable to derivative payments under specific circumstances.

b. Hedging Transactions

Another comment recommended that the final regulations permit netting in the narrow context of related-party hedging transactions. The comment observed that the QDP exception applies to related-party hedging transactions when the taxpayer uses a mark-to-market method of accounting. The comment asserted that there is no policy rationale for limiting netting relief to taxpayers that use a mark-to-market method of accounting; therefore, the comment requested that the QDP exception be expanded to also apply to taxpayers that apply the mark-to-market method for financial accounting purposes. Alternatively, the comment recommended that taxpayers engaged in related- party hedging transactions be permitted to net income items against deduction items.

The final regulations do not provide for a netting rule for related-party hedging transactions. As discussed in Part IV.A.3.a of this Summary of Comments and Explanation of Revisions, permitting netting for related-party hedging transactions would be inconsistent with the statutory framework of section 59A. Furthermore, this recommendation would eliminate or substantially modify one of the three statutory requirements for the QDP exception (that is, use of the mark-to-market accounting method).

c. Clarification of Netting Under Current Law

Finally, some comments recommended that the final regulations clarify when netting is permitted under the Code and regulations, including confirming that netting is permitted for notional principal contracts and for cost sharing transaction payments under § 1.482-7(j)(3)(i). The Treasury Department and the IRS decline to provide such specific guidance because

it is beyond the scope of the final regulations; however, the Treasury Department and the IRS are cognizant that section 59A may place more significance on some sections of the Code than was the case before the Act. The Treasury Department and the IRS intend to study the effect of these provisions on the BEAT and whether changes should be made to the regulations thereunder to better take into account new considerations under the BEAT.

B.

Treatment of Certain Specific Types of Payments

1. Losses Recognized With Respect to the Sale or Transfer of Property to a Foreign Related Party

Section 59A(d) defines a base erosion payment to include any amount paid or accrued by a taxpayer to a foreign related party with respect to which a deduction is allowable. Proposed § 1.59A-3(b)(1)(i) repeats this statutory language. Proposed § 1.59A-3(b)(2)(i) provides that “an amount paid or accrued” includes an amount paid or accrued using any form of consideration, including cash, property, stock, or the assumption of a liability. In explaining this provision, the preamble to the proposed regulations states that “a base erosion payment also includes a payment to a foreign related party resulting in a recognized loss; for example, a loss recognized on the transfer of property to a foreign related party.” REG-104259-18, 83 FR 65956, 65960 (December 21, 2018).

This principle would apply if, for example, a taxpayer transfers to a foreign related party (a) built-in-loss property as payment for a deductible service provided by the foreign related party to the taxpayer (the latter of which may also be a base erosion payment), (b) built-in-loss property as payment for a good or service that the taxpayer is required to capitalize (for example, COGS) such that the payment is not deductible to the taxpayer (the latter of which is not a base erosion payment), or (c) depreciated nonfunctional currency as a payment for a nonfunctional currency denominated amount owed by a taxpayer.

Comments requested that the final regulations revise the definition of a base erosion payment to exclude losses recognized on the sale or exchange of property by a taxpayer to a foreign related party. According to these comments, a payment made with, or a sale of, built-in-loss property is not encompassed within the statutory definition of a base erosion payment. Comments stated that both the statutory and proposed regulations' definition contain two requirements for a payment to be a base erosion payment: There must be (i) an amount paid or accrued by the taxpayer to a foreign person that is a related party of the taxpayer; and (ii) a deduction must be allowable with respect to that amount.

Regarding the first requirement—that there must be an amount paid or accrued by the taxpayer to a foreign related party—when a U.S. taxpayer sells property to a foreign related party for cash, the comments noted that no payment or accrual has taken place by the U.S. taxpayer for purposes of section 59A; rather, the U.S. taxpayer is receiving a cash payment in exchange for the transferred property, and is not making a payment. Thus, the comments argued, the first requirement for a base erosion payment, that a payment or accrual exists, has not been met.

Regarding the second requirement—that a deduction must be allowable with respect to that amount—comments argued that even if a payment is found to have been made to the foreign related party, the deduction for the loss on the built-in-loss property is not with respect to this payment. That is, the comments argued that the loss deduction is not attributable to any “payment” made to the foreign related party (the form of consideration in the transaction); rather, the loss is attributable to the taxpayer's basis in the built-in loss property. Although that built-in-loss is recognized in connection with the transfer to a foreign related party, and thus could meet the statutory requirement as allowed “with respect to” the payment, the comments recommended a narrower interpretation that views the recognized loss as arising independently from the payment, that is viewed as merely a corollary consequence unrelated to the payment being made to the foreign related party.

The final regulations adopt the recommendation provided in these comments. The final regulations clarify the definition of a base erosion payment in § 1.59A-3(b)(1)(i) and (b)(2)(ix) to provide that a loss realized from the form of consideration provided to the foreign related party is not itself a base erosion payment. For the reasons described in the comments and discussed in this Part of the Summary of Comments and Explanation of Revisions, this treatment aligns the definition of base erosion payment with the economics of the payment made by the applicable taxpayer to the foreign related party. That is, the term “base erosion payment” does not include the amount of built-in-loss because that built-in-loss is unrelated to the payment made to the foreign related party. This rule applies regardless of whether the loss realized from the form of consideration provided to the foreign related party is itself consideration for an underlying base erosion payment. To the extent that a transfer of built-in-loss property results in a deductible payment to a foreign related party that is a base erosion payment, the final regulations clarify that the amount of the base erosion payment is limited to the fair market value of that property.

2. Transfers of Property Between Related Taxpayers

The proposed regulations limit the ability of a taxpayer to eliminate base erosion tax benefits by transferring depreciable or amortizable property to another member of the taxpayer's aggregate group. Specifically, proposed § 1.59A-3(b)(2)(vii) provides that if a taxpayer holds depreciable or amortizable property that produces depreciation or amortization deductions that are base erosion tax benefits to the taxpayer, those depreciation or amortization deductions will continue to be treated as a base erosion tax benefit for the acquirer if the taxpayer transfers the property to another member of its aggregate group.

The Treasury Department and the IRS are aware of similar transactions involving a domestic corporation that ordinarily acquires, from a foreign related party, property that is subject to an allowance for depreciation or amortization in the hands of the domestic corporation. In the transaction, the domestic corporation inserts into its supply chain a second domestic corporation, with a principal purpose of avoiding base erosion payments. Specifically, the second domestic corporation, a dealer in property that avails itself of the exclusion of COGS from the definition of a base erosion payment in section 59A(d)(1) and (2), acquires the property from the foreign related party and in turn resells the property to the first domestic corporation. The Treasury Department and the IRS view this type of transaction as already within the scope of the anti-abuse rule set forth in proposed § 1.59A-9(b)(1) (transactions involving unrelated persons, conduits, or intermediaries), and have added an example to the final regulations clarifying the application of this anti-abuse rule to similar fact patterns.

3. Corporate Transactions

The proposed regulations provide that a payment or accrual by a taxpayer to a foreign related party may be a base erosion payment regardless of whether

the payment is in cash or in any form of non-cash consideration.

See

proposed § 1.59A-3(b)(2)(i). There may be situations where a taxpayer incurs a non-cash payment or accrual to a foreign related party in a transaction that meets one of the definitions of a base erosion payment, and that transaction may also qualify under certain nonrecognition provisions of the Code. Examples of these transactions include a domestic corporation's acquisition of depreciable assets from a foreign related party in an exchange described in section 351, a liquidation described in section 332, and a reorganization described in section 368.

The proposed regulations do not include any specific exceptions for these types of transactions even though (a) the transferor of the assets acquired by the domestic corporation may not recognize gain or loss, (b) the acquiring domestic corporation may take a carryover basis in the depreciable or amortizable assets, and (c) the importation of depreciable or amortizable assets into the United States in these transactions may increase the regular income tax base as compared to the non-importation of those assets. In the preamble to the proposed regulations, the Treasury Department and the IRS also note that for transactions in which a taxpayer that owns stock in a foreign related party receives depreciable property from the foreign related party as an in-kind distribution subject to section 301, there is no base erosion payment because there is no consideration provided by the taxpayer to the foreign related party in exchange for the property. REG-104259-18, 83 FR 65956, 65960 (December 21, 2018). Thus, there is no payment or accrual in that transaction.

The preamble to the proposed regulations requests comments about the treatment of payments or accruals that consist of non-cash consideration. REG-104259-18, 83 FR 65956, 65960 (December 21, 2018). Comments have suggested that corporate nonrecognition transactions or transactions in which U.S. taxpayers do not obtain a step-up in the tax basis of an acquired asset should not be treated as a base erosion payment. They argued that these nonrecognition transactions should not be treated as a payment or accrual. Based on this position, some comments argued either that the Treasury Department and the IRS do not have the authority to treat nonrecognition transactions as base erosion payments or that the better policy is to exclude nonrecognition transactions from the definition of base erosion payments. Furthermore, comments argued that nonrecognition provisions such as sections 332, 351, and 368 reflect the judgment of Congress that certain corporate transactions such as the formation and dissolution of businesses and the readjustment of continuing interests in property do not warrant the imposition of tax. They also argued that the legislative history of section 59A does not suggest that Congress intended for it to apply to nonrecognition transactions.

With regard to section 332 liquidations, comments argued that a section 332 liquidation should not be treated as a base erosion payment when a section 301 distribution is not. Furthermore, comments argued that transactions in which stock is merely deemed to be exchanged, like certain section 351 transactions or section 332 liquidations, should not be treated as base erosion payments since there is no actual transfer of shares.

Comments also argued that nonrecognition transactions are not base eroding. Comments asserted that inbound nonrecognition transactions are often used in post-acquisition restructurings, as well as in other internal restructurings to better align a multinational organization's legal structure with its commercial operations. Comments also argued that treating these transactions as base erosion payments would provide a disincentive to move intangible property and other income-producing property into the United States, contrary to the goals of the Act.

Furthermore, comments argued that amortization of a carryover tax basis of an asset acquired by a U.S. taxpayer from a related party in a nonrecognition transaction would not create the same base erosion concerns as other types of deductions. However, comments acknowledged that, if final regulations adopted a broad exception for nonrecognition transactions, taxpayers could abuse that exception by engaging in certain basis step-up transactions immediately before an inbound nonrecognition transfer. Comments suggested that augmenting the conduit anti-abuse rule of proposed § 1.59A-9 may be sufficient to prevent these types of transactions. Alternatively, comments also suggested that, to delineate cases of potential abuse, a rule similar to the 5-year active trade or business rules in § 1.355-3 could apply to specify instances when assets would qualify as not being “recently stepped up assets.”

Comments generally supported the statement in the preamble to the proposed regulations that a section 301 distribution is not treated as a base erosion payment because there is no exchange, and requested that the exclusion be included in the final regulations as well as the preamble. Comments also requested that the definition of a base erosion payment also exclude exchanges (including section 302 and 304 transactions) that are treated as section 301 distributions pursuant to section 302(d).

Comments have generally acknowledged that the taxable transfer of depreciable or amortizable property in exchange for stock should be subject to the BEAT. For example, comments stated that the transfer of assets to a corporation that is partially taxable to the transferor pursuant to section 351(b) or 356 as a result of the receipt of “boot” by the transferor is appropriately treated as a base erosion payment. The amount of the base erosion payment could be determined based on the gain or increase in basis of the property, the amount of boot allocated to the property, or by treating all of the boot as paid for depreciable or amortizable property first, to the extent thereof. Comments also requested clarity on the treatment of the assumption of liabilities pursuant to a nonrecognition transaction. One comment requested that the assumption of liabilities in a nonrecognition transaction be excluded from the definition of a base erosion payment to the extent that the assumption is not treated as money or other property. This comment suggested that, if the Treasury Department and the IRS are concerned about abusive transactions, an anti-abuse rule could be designed to treat certain liabilities as base erosion payments.

Similarly, comments stated that the taxable transfer of assets to a domestic corporation in exchange for stock, such as in a so-called “busted section 351 transaction,” should be subject to the BEAT. Comments also discussed whether a taxable distribution to a domestic corporation in a section 331 liquidation of a foreign corporation should be subject to the BEAT. These comments acknowledged that taxable transactions generally give rise to base erosion payments and did not take a view on whether section 331 liquidations should be subject to the BEAT. Accordingly, comments requested that nonrecognition transactions be excluded from the definition of a base erosion payment only to the extent that the U.S. taxpayer obtains a carryover basis in the acquired asset. Alternatively, comments have requested a safe harbor that would exclude nonrecognition transactions that are part of post-acquisition restructuring to allow taxpayers to transfer into the United States

intellectual property that was recently acquired from a third party. Comments have also requested that final regulations clarify that nonrecognition transactions that occurred before the effective date of the BEAT will not be treated as base erosion payments.

Finally, comments have noted that a nonrecognition transaction involving a U.S. branch of a foreign corporation may not qualify for the ECI exception under proposed § 1.59A-3(b)(3)(iii) for payments that are treated as effectively connected income in the hands of the payee, because the ECI exception under proposed § 1.59A-3(b)(3)(iii) is predicated on the payment or accrual being subject to U.S. federal income taxation, which cannot occur when the transaction is not taxable.

Consistent with these comments, the final regulations generally exclude amounts transferred to, or exchanged with, a foreign related party in a transaction described in sections 332, 351, and 368 (“corporate nonrecognition transaction”) from the definition of a base erosion payment. In light of the comments, the Treasury Department and the IRS have determined a limited exclusion of corporate nonrecognition transactions is consistent with the underlying anti-base erosion purpose of the BEAT, tends to reduce disincentives for taxpayers to move intangible property and other income-producing property into the United States in corporate nonrecognition treatment transactions, and is consistent with the general treatment of corporate nonrecognition transactions under other sections of the Code. However, the Treasury Department and the IRS have determined that it is not appropriate to apply this exception to the transfer of other property, or property transferred in exchange for other property, in a corporate nonrecognition transaction. Solely for purposes of determining what is a base erosion payment, “other property” has the meaning of other property or money, as used in sections 351(b), 356(a)(1)(B), and 361(b), as applicable, including liabilities described in section 357(b). However, other property does not include the sum of any money and the fair market value of any property to which section 361(b)(3) applies. Other property also includes liabilities that are assumed by the taxpayer in a corporate nonrecognition transaction, but only to the extent of the amount of gain recognized under section 357(c).

For example, if a foreign corporation transfers depreciable property to its wholly owned domestic subsidiary in a transaction to which section 351 applies, and if the foreign corporation receives subsidiary common stock and cash in exchange, the cash may be treated as a base erosion payment, while the common stock is not. Similarly, property transferred in a section 351 or 368 transaction in exchange, in whole or in part, for other property may be a base erosion payment if it otherwise meets the definition of a base erosion payment. For example, if a domestic corporation transfers property to its wholly-owned foreign subsidiary in a transaction to which section 351 applies, and if the domestic corporation receives common stock in the foreign corporation and other property consisting of depreciable property, the property transferred by the domestic corporation may be a base erosion payment. These rules apply without regard to whether or not gain or loss is recognized in the transaction.

When a taxpayer transfers other property to a foreign related party, or transfers property to a foreign related party in exchange for other property, the determination of the amount of property that is treated as received from the foreign related party in exchange for the property transferred to the foreign related party is based on U.S. federal income tax law. See, for example, Rev. Rul. 68-55, 1968-1 C.B. 140.

Consistent with concerns raised by comments, the Treasury Department and the IRS are concerned that the exclusion of nonrecognition transactions could lead to inappropriate results in certain situations. An example of an inappropriate result is the sale of depreciable property between foreign related parties shortly before a nonrecognition transaction, which could step up the taxpayer's basis in the property and increase depreciation or amortization deductions of the domestic corporation after the nonrecognition transaction relative to the alternative in which the step-up basis transactions did not occur. Accordingly, the Treasury Department and the IRS have determined that it is appropriate to specifically address these transactions with an anti-abuse rule.

See

§ 1.59A-9(b)(4). The anti-abuse rule applies in addition to, and in conjunction with, section 357(b). In addition, the Treasury Department and the IRS observe that, because the BEAT is applied after the application of general U.S. federal income tax law, other doctrines—including the step transaction doctrine and economic substance doctrine—also may apply.

Because the final regulations provide an exception for corporate nonrecognition transactions, it is not necessary for the final regulations to include other suggested modifications, such as (i) modifying the ECI exception for nonrecognition transactions involving U.S. branches, (ii) providing a safe harbor that would exclude nonrecognition transactions that are part of a post-acquisition restructuring, or (iii) clarifying that nonrecognition transactions that occurred before the effective date of the BEAT are not treated as base erosion payments.

The final regulations also clarify the treatment of distribution transactions, such as distributions described in section 301, and redemption transactions, such as redemptions described in section 302. A distribution with respect to stock for which there is no consideration (a “pure distribution”) is not treated as an exchange. Accordingly, the final regulations provide that a pure distribution of property made by a corporation to a shareholder with respect to its stock is not an amount paid or accrued by the shareholder to the corporation. These pure distributions include distributions under section 301, without regard to the application of section 301(c) to the shareholder (addressing distributions in excess of earnings and profits). § 1.59A-3(b)(2)(ii). However, unlike a pure distribution, a redemption of stock in exchange for property constitutes an exchange. Accordingly, the final regulations provide that a redemption of stock by a corporation within the meaning of section 317(b) (such as a redemption described in section 302(a) and (d) or section 306(a)(2)), or an exchange of stock described in section 304 or section 331, is an amount paid or accrued by the shareholder to the corporation (or by the acquiring corporation to the transferor in a section 304 transaction).

4. Interest Expense Allocable to a Foreign Corporation's Effectively Connected Income

a. In General

Section 59A applies to foreign corporations that have income that is subject to net income taxation as effectively connected with the conduct of a trade or business in the United States, taking into account any applicable income tax treaty of the United States. The proposed regulations generally provide that a foreign corporation that has interest expense allocable under section 882(c) to income that is effectively connected with the conduct of a trade or business within the United States will have a base erosion payment to the extent the interest expense results from a payment or accrual to a foreign related party. The amount of interest that will be treated as

a base erosion payment depends on the method used under § 1.882-5.

If a foreign corporation uses the three-step method described in § 1.882-5(b) through (d), the proposed regulations provide that interest on direct allocations and on U.S.-booked liabilities that is paid or accrued to a foreign related party will be a base erosion payment.

1

See

proposed § 1.59A-3(b)(4)(i)(A). If U.S.-booked liabilities exceed U.S.-connected liabilities, the proposed regulations provide that a foreign corporation computing its interest expense under this method must apply the scaling ratio to all of its interest expense on a pro-rata basis to determine the amount that is a base erosion payment. The amount of interest on excess U.S.-connected liabilities that is a base erosion payment is equal to the interest on excess U.S.-connected liabilities multiplied by the foreign corporation's ratio of average foreign related-party liabilities over average total liabilities.

See

proposed § 1.59A-3(b)(4)(i)(A)(

2

).

1

For purposes of § 1.882-5, direct allocations generally refer to the requirement that a foreign corporation allocate interest expense to income from particular assets; these circumstances generally arise with respect to (i) certain assets that are subject to qualified nonrecourse indebtedness or (ii) certain assets that are acquired in an integrated financial transaction.

If a foreign corporation determines its interest expense under the separate currency pools method described in § 1.882-5(e), the proposed regulations provide that the amount of interest expense that is a base erosion payment is equal to the sum of (1) the interest expense on direct allocations paid or accrued to a foreign related party and (2) the interest expense in each currency pool multiplied by the ratio of average foreign related-party liabilities over average total liabilities for that pool.

See

proposed § 1.59A-3(b)(4)(i)(B).

Comments requested that a consistent method apply to determine the portion of interest allocated to a U.S. branch that is treated as paid to a foreign related party. The comments noted that the methods in the proposed regulations may produce meaningfully different amounts of base erosion payments depending on which method the taxpayer uses to determine its branch interest expense. Comments noted that a branch that uses the method described in § 1.882-5(b) through (d) may have a lower amount of base erosion payments than a branch using the method described in § 1.882-5(e) or a permanent establishment applying a U.S. tax treaty, although those differences will ultimately depend on the composition of the counterparties of the U.S.-booked liabilities and the excess U.S.-connected liabilities (as foreign related parties or not foreign related parties). See also Part IV.B.5 of this Summary of Comments and Explanation of Revisions for a discussion of interest allowed to permanent establishments applying a U.S. tax treaty. The comments argued that these differences are not supported by tax policy.

Comments generally requested a rule permitting or requiring foreign corporations to use U.S.-booked liabilities to determine the portion of U.S. branch interest expense that is treated as paid to foreign related parties, consistent with the method described in the proposed regulations for corporations that determine U.S. branch interest expense using the method described in § 1.882-5(b) through (d), even if the U.S. branch uses a different method to determine its interest expense. The comments argued that U.S. assets are used to determine the amount of leverage that is properly allocable to a U.S. branch, and, as a result, U.S.-booked liabilities should determine the amount of interest treated as a base erosion payment. Specifically with regard to banks, a comment argued that banks are highly regulated with limited or no ability to manipulate U.S.-booked liabilities, and, as a result, should be permitted to use U.S.-booked liabilities to determine the amount of U.S. branch interest expense treated as paid to foreign related parties.

The Treasury Department and the IRS agree that the rules for determining the portion of U.S. branch interest paid to foreign related parties should be consistent, regardless of whether taxpayers apply the method described in § 1.882-5(b) through (d) or § 1.882-5(e). For purposes of section 59A, the Treasury Department and the IRS agree that the starting point for determining the identity of the recipient should be the U.S. booked liabilities of the U.S. branch. The final regulations, therefore, provide that the amount of U.S. branch interest expense treated as paid to a foreign related party is the sum of: (1) The directly allocated interest expense that is paid or accrued to a foreign related party, (2) the interest expense on U.S.-booked liabilities that is paid or accrued to a foreign related party, and (3) the interest expense on U.S.-connected liabilities in excess of interest expense on U.S.-booked liabilities multiplied by the ratio of average foreign related-party interest over average total interest (excluding from this ratio interest expense on U.S. booked liabilities and interest expense directly allocated).

See

§ 1.59A-3(b)(4)(i)(A);

see also

Part IV.B.4.b.i of this Summary of Comments and Explanation of Revisions (discussing the change from a worldwide liability ratio to a worldwide interest ratio). In adopting a consistent approach, the final regulations use the same ratio to determine whether the interest expense on U.S.-connected liabilities is paid to a foreign related party regardless of whether a taxpayer applies the method described in § 1.882-5(b) through (d) or § 1.882-5(e).

See

§ 1.59A-3(b)(4)(i)(A)(3).

b. Simplifying Conventions

The Treasury Department and the IRS recognize that § 1.882-5 provides certain simplifying elections for determining the interest deduction of a foreign corporation. The proposed regulations request comments about similar simplifying elections for determining the portion of U.S.-connected liabilities that are paid to a foreign related party for purposes of section 59A. REG-104259-18, 83 FR 65956, 65960 (December 21, 2018).

Comments, in response to the request for comments on simplifying conventions, indicated that it may be difficult for foreign corporations to determine their worldwide ratio of liabilities owed to foreign related parties over total liabilities (“worldwide liabilities ratio”). For example, they argued that U.S. branches of foreign banks typically do not have full access to information about the bank's global operations and funding arrangements. These comments argued that even if a U.S. branch does have that information, U.S. tax law may treat some transactions as debt that non-U.S. tax law does not, or may integrate some hedging costs that are not integrated for non-U.S. tax purposes, or vice-versa. These comments further observed that if the taxpayer is using the fixed ratio election for purposes of § 1.882-5, the taxpayer would not be required to obtain that information or reconcile the home office balance sheet to U.S. tax law principles for purposes of § 1.882-5. Thus, the comments argued that attempting to reconstruct a global balance sheet and payments under U.S. tax principles for purposes of proposed § 1.59A-3 is burdensome and should not be required.

The comments also requested various simplifying elections for determining the amount of U.S. branch interest treated as paid to foreign related parties, including (a) computing the worldwide ratio by reference to interest expense rather than worldwide liabilities (“worldwide interest ratio”), (b) using financial accounting books and records rather than U.S. tax principles to determine a worldwide ratio, or (c)

providing a fixed ratio for purposes of determining the minimum amount of interest treated as paid to third parties (such as 85 percent).

i. Worldwide Interest Ratio

The final regulations adopt the comment recommending that taxpayers apply the worldwide ratio to determine the amount of a U.S. branch's interest expense paid to foreign related parties by reference to a worldwide ratio of interest expense, rather than a worldwide ratio of liabilities.

See

§ 1.59A-3(b)(4)(i)(A)(3). The final regulations adopt this approach as a rule, rather than as an election, because the Treasury Department and the IRS agree with the comments that a worldwide ratio based on interest expense, rather than liabilities, is the appropriate measurement for determining a U.S. branch's base erosion payments. Section 59A determines the amount of interest that is a base erosion payment based on the amount of interest paid or accrued to foreign related parties, rather than the amount of liabilities owed to foreign related parties. Accordingly, the final regulations determine the amount of a U.S. branch's interest expense treated as a base erosion payment based on the foreign corporation's worldwide interest ratio.

ii. Use of Applicable Financial Statements

The Treasury Department and the IRS recognize that it may be difficult for foreign corporations to determine their worldwide interest ratio under U.S. tax principles, as indicated by the comments. Accordingly, for simplicity and to reduce the administrative burden on taxpayers, the final regulations adopt the comment to allow taxpayers to elect to determine their worldwide interest ratio using their applicable financial statements as described in section 451(b)(3).

See

§ 1.59A-3(b)(4)(i)(D). The final regulations also clarify that the applicable financial statement must be the applicable financial statement of the taxpayer, not a consolidated applicable financial statement, because a consolidated applicable financial statement may eliminate inter-company liabilities. The final regulations provide that a taxpayer makes this election on Form 8991 or a successor form. Until the Form 8991 is revised to incorporate the election, a taxpayer should attach a statement with that form to make this election as provided in forms and instructions.

iii. Fixed Ratio or Safe Harbor for the Worldwide Interest Ratio

The final regulations do not adopt a fixed ratio or safe harbor for the worldwide interest ratio as suggested in comments because the actual worldwide interest ratio of an enterprise may vary significantly from one industry to another and from one taxpayer to another. As a result, it is not possible to establish a single safe harbor that appropriately takes into account the differing position of industries and taxpayers while protecting the interests of the government. The Treasury Department and the IRS recognize that § 1.882-5 provides other safe harbors, such as the fixed ratio safe harbor for determining the ratio of liabilities to assets of 95 percent for banks and 50 percent for other taxpayers. § 1.882-5(c)(4). In the context of determining the portion of a U.S. branch's interest expense that is deemed attributed to foreign related parties (versus other persons), the Treasury Department and the IRS determined that there is not a sufficient basis to establish a safe harbor because different taxpayers could have different internal capital structures.

One comment suggested that a U.S. branch of a bank should be permitted to assume that 85 percent of its funding is from unrelated lenders because regulations under section 884 provide a safe harbor assumption that 85 percent of a bank's capital can be deemed to come from deposits (and thus eligible for the bank deposit interest exemption from the tax imposed by section 881(a)).

See

§ 1.884-4(a)(2)(iii). The section 884 safe harbor, however, is not relevant to the determination of the ratio of funding from foreign related parties because the bank deposit exception is available for both related and unrelated depositors/lenders. Thus, this section 884 safe harbor does not reflect the expected percentage of the lenders who are not foreign related parties.

See

section 871(i)(2) and section 881(d).

c. Other Coordinating Rules

The final regulations also revise § 1.59A-3(b)(4)(1) to take into account the expansion of the exception for certain total loss-absorbing capacity securities to include foreign issuers. See Part IV.C.5 of this Summary of Comments and Explanation of Revisions (Exception for Interest on Certain Instruments Issued by Globally Systemically Important Banking Organizations).

Finally, a comment recommended that the final regulations revise proposed § 1.59A-3(b)(4)(i)(D), which provides that to the extent that a taxpayer makes an election to reduce its U.S.-connected liabilities pursuant to § 1.884-1(e)(3), the reduction is treated as proportionally reducing all liabilities for purposes of determining the amount of allocable interest expense that is treated as a base erosion payment. The comment argued that § 1.59A-3(b)(4)(i)(D) is inconsistent with § 1.884-1(e)(3), which applies for all purposes of the Code, and which the comment asserted does not require proportionate reduction. In response to this comment, the final regulations do not include the rule in proposed § 1.59A-3(b)(4)(i)(D). The Treasury Department and the IRS are considering § 1.884-1(e)(3) for possible future guidance.

5. Allocations of Interest and Other Expenses Pursuant to Income Tax Treaties

The proposed regulations provide a specific rule for determining the amount of base erosion payments attributable to interest and deductions allocated to a permanent establishment under a U.S. income tax treaty. Certain U.S. income tax treaties provide alternative approaches for the allocation or attribution of business profits of an enterprise of one contracting state to its permanent establishment in the other contracting state on the basis of assets used, risks assumed, and functions performed by the permanent establishment. These treaties allow notional payments that take into account interbranch transactions and value the interbranch transactions using the most appropriate arm's length method for those transactions. A treaty-based expense allocation or attribution method does not itself create legal obligations between the U.S. permanent establishment and the rest of the enterprise. The proposed regulations reflect that under a treaty-based expense allocation or attribution method, amounts equivalent to deductible payments may be allowed in computing the business profits of an enterprise with respect to transactions between the permanent establishment and the home office or other branches of the foreign corporation (“internal dealings”). The deductions from internal dealings would not be allowed under the Code and regulations. The proposed regulations provide that deductions from internal dealings allowed in computing the business profits of the permanent establishment are base erosion payments.

The proposed regulations distinguish between the allocations of expenses and internal dealings. The allocation and apportionment of expenses of the

enterprise to the branch or permanent establishment is not a base erosion payment because the allocation represents a division of the expenses of the enterprise, rather than a payment between the branch or permanent establishment and the rest of the enterprise. Internal dealings, however, are not mere divisions of enterprise expenses; rather, internal dealings are priced on the basis of assets used, risks assumed, and functions performed by the permanent establishment in a manner consistent with the arm's length principle. The proposed regulations create parity between deductions for actual regarded payments between two separate corporations (which are subject to section 482), and internal dealings (which are generally priced in a manner consistent with the applicable treaty and, if applicable, the OECD Transfer Pricing Guidelines). The proposed regulations apply only to deductions attributable to internal dealings, and not to payments to entities outside of the enterprise, which are subject to the general base erosion payment rules as provided in proposed § 1.59A-3(b)(4)(v)(A).

Comments noted that internal dealings are a fiction and do not involve an actual payment or accrual under general U.S. tax principles. The comments suggested that internal dealings should be relevant only for purposes of determining the profit attributable to the permanent establishment and should not be recognized for other purposes. They noted that the OECD 2010 Report on the Attribution to Profits to Permanent Establishments (“2010 OECD Report”) states that recognizing internal dealings by a permanent establishment “is relevant only for the attribution of profits” and “does not carry wider implications as regards, for example, withholding taxes.” 2010 OECD Report (July 22, 2010), Part IV, C-1(iii)(f), section 166. Thus, comments suggested that internal dealings should not be relevant for BEAT purposes.

The Treasury Department and the IRS disagree that internal dealings are not relevant for purposes of determining a foreign corporation's base erosion payments. Unlike the allocation of a foreign corporation's deductions to a U.S. branch under the Code and regulations, internal dealings are not a mere allocation of expenses, but rather are determined on the basis of assets used, risks assumed, and functions performed by the permanent establishment in a manner consistent with the arm's length principle. Deductions determined under internal dealings, like deductions determined under the Code and regulations, reduce the U.S. income tax base of the permanent establishment. Because internal dealings are not an allocation of expenses, the foreign corporation's worldwide ratio may not be an appropriate measure of related party payments. Instead, in the proposed regulations, the Treasury Department and the IRS determined that it is appropriate to look to the internal dealings, rather than the foreign corporation's worldwide expenses, for purposes of determining base erosion payments.

However, the Treasury Department and the IRS recognize that interest expense allowed to a permanent establishment as internal dealings often represents interest expense on back-to-back loans between (1) the permanent establishment and the home office, and (2) the home office and another entity. Furthermore, unlike other deductions that are often based on payments to the home office or to another branch for goods or services or the use of intellectual property unique to the home office or branch, money is fungible. A permanent establishment may be indifferent to whether its capital comes from the home office or a loan from another entity.

The Treasury Department and the IRS have determined that interest expense determined under § 1.882-5 generally provides a reasonable estimate of the amount of interest of the foreign corporation that should be allocated to the permanent establishment based on the assets of the permanent establishment. Accordingly, it is appropriate to treat interest expense determined in accordance with a U.S. tax treaty (including interest expense determined by internal dealings) in a manner consistent with the treatment of interest expense determined under § 1.882-5, to the extent it would have been allocated to the permanent establishment under § 1.882-5. In effect, the internal dealing permits the permanent establishment to replace an external borrowing with an internal dealing, and this internal dealing should be treated as creating additional interest expense paid to the home office, and thus treated as a base erosion payment to a foreign payee. Accordingly, interest expense determined in accordance with a U.S. tax treaty (including interest expense determined by internal dealings) that is in excess of the amount that would have been allocated to the permanent establishment under § 1.882-5 is treated as interest expense paid by the permanent establishment to the home office or another branch of the foreign corporation.

Specifically, the final regulations treat interest expense determined in accordance with a U.S. tax treaty (including interest expense determined by internal dealings) in a manner consistent with the treatment of interest expense determined under § 1.882-5, to the extent of the hypothetical amount of interest expense that would have been allocated to the permanent establishment under § 1.882-5 (the “hypothetical § 1.882-5 interest expense”). For purposes of this calculation, the hypothetical § 1.882-5 interest expense cannot exceed the amount of interest expense determined under the U.S. tax treaty. Interest expense in excess of the hypothetical § 1.882-5 interest expense is treated as interest expense paid by the permanent establishment to the home office or another branch of the foreign corporation, and therefore is treated as a base erosion payment.

See

§ 1.59A-3(b)(4)(i)(E).

Accordingly, under the final regulations, a foreign corporation determines its hypothetical § 1.882-5 interest expense by calculating the amount of interest that would have been allocated to effectively connected income if the foreign corporation determined its interest expense under § 1.882-5.

See

§ 1.59A-3(b)(4)(i)(E)(2). Therefore, a foreign corporation will use the method provided in § 1.59A-3(b)(4)(i)(A), as described in Part IV.B.4.a in this Summary of Comments and Explanation of Provisions, to determine its hypothetical § 1.882-5 interest expense.

In this regard, the Treasury Department and the IRS observe that corporations eligible for benefits under a U.S. income tax treaty are permitted to choose whether to apply the treaty or the Code and regulations to calculate interest expense allocable to a permanent establishment or U.S. branch, and understand that many corporations eligible for treaty benefits calculate interest expense allocated to a U.S. branch or permanent establishment under both § 1.882-5 and the applicable treaty to determine whether to claim treaty benefits. Additionally, the Treasury Department and the IRS also understand that corporations that determine interest expense allowed to a permanent establishment under a U.S. income tax treaty may nonetheless be required to allocate interest to the permanent establishment under § 1.882-5 for state or local tax purposes.

6. Related-Party Hedging Payments

Comments requested that the final regulations provide relief from the application of the BEAT for hedging

payments made by domestic corporations to foreign related parties, specifically in the context of the energy industry. The comments described a scenario in the energy industry where large multinational groups designate one or more members of their worldwide group to act as a hedging center to manage price risk associated with commodities that the group produces or sells through the execution of commodities derivatives. The comments indicated that under prevailing industry practice and applicable financial accounting standards, income, gain, loss, or expense on commodity derivatives are often accounted for as items of COGS or as a reduction to determine gross income for book accounting purposes. These items, however, are not treated as COGS or as another form of reduction to determine gross income for tax purposes; the items are deductions for tax purposes and potentially within the scope of section 59A(d)(1) and proposed § 1.59A-3(b)(1)(i). The payments described in these comments are not eligible for the QDP exception in section 59A(h) and proposed § 1.59A-6. The comments requested that the final regulations include a rule that related-party hedging payments are not base erosion payments.

The final regulations do not adopt this recommendation. The status of an item as a deduction is determined under U.S. federal income tax law, not industry practice or financial accounting treatment. Although the legislative history of section 59A states that base erosion payments do not include any amount that constitutes reductions to determine gross income, including payments for COGS, these statements are in the context of U.S. federal income tax law, which sets forth the tax law for deductions. In addition, section 59A(d)(1) refers to “deductions allowable under this chapter,” that is, chapter 1 (normal taxes and surtaxes) of Subtitle A (income taxes) of the Code, which includes section 1 through section 1440Z-2. Congress did not indicate that the definition of a reduction to determine gross income or COGS for purposes of section 59A should be derived from financial accounting principles. In the absence of clear Congressional intent otherwise, the Treasury Department and the IRS believe that whether an amount constitutes a reduction to determine gross income or COGS must be determined under established principles of U.S. federal income tax law. Consequently, if related-party hedging payments are not properly treated as reductions to determine gross income for tax purposes, these payments are not excluded from the definition of base erosion payments. See also Part IV.A.3.b of this Summary of Comments and Explanation of Revisions (Netting of income and expense; Hedging transactions).

7. Captive Finance Subsidiaries

Comments addressed the impact of the BEAT on domestic corporate captive finance subsidiaries that purchase property (business equipment) from a foreign related party and then lease the property to unrelated third party end users. The comments requested that the final regulations permit taxpayers using this type of business model to treat the depreciation deductions attributable to the leased property as COGS for purposes of the BEAT. The comments premised this requested treatment on the theory that the cost of the leased property and its associated depreciation deductions are directly correlated with the rental income generated from leasing the property and on the unique nature of this particular business model.

The final regulations do not include an exception from the definition of base erosion payments for the transactions described in these comments. Under section 59A(d)(2), the deduction allowed for depreciation with respect to property acquired from a foreign related party is a base erosion tax benefit, notwithstanding that the property acquired by the taxpayer is used in an income-generating business in the United States, such as the leasing of the business equipment to unrelated third party lessees of the property or operating the business equipment itself as a service for unrelated third parties.

8. Capitalization and Amortization of Research and Experimental Expenditures

One comment recommended that the final regulations clarify the treatment of research and experimental (“R&E”) expenditures after such costs are required to be amortized in taxable years beginning after December 31, 2021, under section 174. The comment recommended clarification that after the change to section 174 is in effect, the BEAT payment associated with R&E expenses is limited to the amount of amortization. The final regulations do not adopt this comment because the Treasury Department and the IRS view § 1.59A-3(b)(1)(i) and § 1.59A-3(c)(1)(i) as sufficiently clear in setting forth that a base erosion payment to a foreign related party does not result in a base erosion tax benefit until the deduction is “allowed under chapter 1 of subtitle A of the [Code].”

C. Other Exceptions From the Base Erosion Payment Definition Contained in the Proposed Regulations

1. Exception for Certain Amounts With Respect to Services and the Services Cost Method

Proposed § 1.59A-3(b)(3)(i) provides that a base erosion payment does not result from amounts paid or accrued to a foreign related party for services that are eligible for the SCM exception described in proposed § 1.59A-3(b)(3)(i)(B), but only to the extent of the total services cost of those services. Any amount paid or accrued to a foreign related party in excess of the total services cost of services eligible for the SCM exception (the mark-up component) remains a base erosion payment. Proposed § 1.59A-3(b)(3)(i)(B) provides that the SCM exception applies if all of the requirements of § 1.482-9(b), which describes the SCM, are satisfied, with two exceptions. First, the requirements of § 1.482-9(b)(5), commonly referred to as the business judgment rule, do not apply. Second, the books and records requirement described in § 1.482-9(b)(6) is replaced with the requirements of proposed § 1.59A-3(b)(3)(i)(C). Section 1.482-9(b)(4) provides that certain activities, including research, development, and experimentation, are not eligible for the SCM. As a result, payments for these services do not qualify for the SCM exception described in proposed § 1.59A-3(b)(3)(i)(B).

Comments supported the SCM exception and recommended that final regulations adopt this approach. The final regulations continue to provide that the SCM exception is available for the cost portion of a payment that otherwise meets the requirements for the SCM exception. A comment recommended that the final regulations provide examples or clarification as to the requirement in proposed § 1.59A-3(b)(3)(i)(C) that taxpayers' books and records provide sufficient documentation to allow verification of the methods used to allocate and apportion the costs to the services in question in accordance with § 1.482-9(k). The final regulations include additional detail on the documentation required to satisfy this requirement. § 1.59A-3(b)(3)(i)(C).

Comments also recommended that the final regulations extend the SCM exception to the cost element of payments for other types of services that are not eligible for the SCM. Some comments suggested that an exception

should be available for all services. Some comments suggested that an exception should be available for services that are excluded under § 1.482-9(b)(4) (excluded activities) but that otherwise would be eligible for the SCM exception described in proposed § 1.59A-3(b)(3)(i)(B). Some comments suggested that an exception should be available for research and experimentation services.

Comments suggested that applying the SCM exception to only some services will lead to inequitable results for services companies as compared to similarly situated U.S. manufacturers and distributors because the definition of base erosion payments does not include payments included in COGS, but there is not a similar rule for the costs in a services business. Comments also claimed that, relative to manufacturers or distributors, service companies are more constrained in where they operate. Comments also asserted that no base erosion could result from an expansion of the SCM exception because only the cost element of the service fee would be subject to the exception.

The comments suggesting that an exception should be available for excluded activities that otherwise would be eligible for the SCM also asserted that the list of excluded activities serves a similar purpose as the business judgment rule, which is to identify services for which total services costs can constitute an inappropriate reference point for determining profitability or that should be subject to a more robust transfer pricing analysis. Comments suggested that § 1.482-9(b)(4) is essentially a list of specific activities for which the SCM is unavailable because they are deemed to contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure of the business. These comments suggested that when section 59A(d) states that the exception therein is based on compliance with the services cost exception in section 482 “(determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure)”, that language was intended to disregard the list of excluded activities.

The comments requesting an expansion of the SCM exception for research and experimentation services also asserted that extending the SCM exception to these services would reduce the incentive to move intangible property offshore and would broaden the U.S. tax base by encouraging U.S. ownership and exploitation of newly created intangible property.

Section 59A(d)(5)(A) sets forth the parameters under which certain services—those that are eligible for the SCM without regard to the business judgment rule—are eligible for the SCM exception. The Treasury Department and IRS have considered the policy considerations that the comments raised for expanding the SCM exception, but have determined that the recommendation to expand the SCM exception is inconsistent with the parameters that Congress set forth in section 59A(d)(5). Further, the Treasury Department and IRS disagree with the premise in the comments that the list of excluded activities serves the same purpose as the business judgment rule. While certain services that are ineligible for the SCM as a result of being on the list of excluded activities also may be ineligible for the SCM as a result of failing the business judgment rule, the list of excluded activities from the SCM provides an objective list of categories that tend to be high margin or for which the cost of the services tends to be an inappropriate reference point for the price of those services.

See

71 FR 44466, 44467-68 (Aug. 4, 2006). By contrast, the business judgment rule also excludes from the SCM services that tend to be low margin as a general matter, but in the context of a particular business are a core competency of the business.

See

71 FR 44466, 44467 (Aug. 4, 2006). The parenthetical language in section 59A(d)(5)(A) indicates unambiguously that Congress intended the SCM exception to be available for all services that are typically low margin even if, in the context of a particular business, the service is a core competency of a business that may not satisfy the criteria in § 1.482-9(b)(5). Accordingly, the Treasury Department and the IRS have determined that the SCM exception should continue to follow the statute, and the rule is unchanged from the proposed regulations.

2. Qualified Derivatives Payments

For a discussion of QDPs, see Part VII of this Summary of Comments and Explanation of Revisions.

3. Exception to Base Erosion Payment Status for Payments the Recipient of Which Is Subject to U.S. Tax

Proposed § 1.59A-3(b)(3)(iii) generally provides that a base erosion payment does not result from amounts paid or accrued to a foreign related party that are subject to tax as income effectively connected with the conduct of a trade or business in the United States (ECI). Comments recommended that final regulations adopt this rule. Accordingly, this rule is unchanged in the final regulations.

Several comments recommended that final regulations include a similar exception from the definition of a base erosion payment for payments made by a domestic corporation to a controlled foreign corporation (CFC) that result in a subpart F or global intangible low tax income (GILTI) inclusion. Another comment requested that this exception be extended to apply to payments made to a passive foreign investment company (PFIC) when a U.S. person has made a qualified electing fund (QEF) election, and the payment is included in the electing U.S. person's gross income. The comments asserted that payments that give rise to a subpart F or GILTI inclusion do not erode the U.S. tax base, and accordingly, warrant a base erosion payment exception under the same policy rationale for granting this type of exception in the proposed regulations for ECI, section 988 losses, and interest paid with respect to total loss-absorbing capacity (TLAC) securities. Finally, comments noted that proposed regulations under section 267A provide an exception for certain payments that result in income inclusions under section 951 and section 951A and suggested equivalent treatment was justified in the case of the BEAT.

The final regulations do not include a subpart F, GILTI, or PFIC exception to base erosion payment status. The Treasury Department and the IRS have determined that the reasons for adopting the other exceptions cited in the comments (such as the ECI exception and the exception under section 267A) do not warrant a subpart F, GILTI, or QEF exception from base erosion payment status.

First, comments have misinterpreted the underlying policy rationale for providing an ECI exception in the proposed regulations. The proposed regulations' ECI exception was adopted in part based upon the determination that it would be appropriate in defining a base erosion payment to consider the U.S. federal tax treatment of the foreign recipient—particularly, whether a payment received by a foreign related party was subject to tax on a net basis in substantially the same manner as amounts paid to a U.S. person. In contrast to the tax directly imposed on a foreign person with respect to its ECI under sections 871(b) and 882(a), a CFC receiving a base erosion payment is not directly subject to U.S. taxation. Rather, the U.S. shareholder is subject to tax under the subpart F or GILTI regime (or the PFIC rules). Thus, the CFC recipient

(or PFIC recipient) of a payment is not itself subject to tax on a net basis in substantially the same manner as a U.S. person.

In addition, a foreign corporation that is engaged in a U.S. trade or business is itself subject to section 59A. In contrast, because neither a CFC nor a PFIC is subject to section 59A, the CFC or PFIC can make payments to a foreign related party without any BEAT consequences.

The ECI exception was also adopted to achieve symmetry with proposed § 1.59A-2(c), which treats foreign corporations as outside of the controlled group, except to the extent that the foreign corporation has ECI. Because foreign corporations with ECI are treated as part of the aggregate group in determining whether a taxpayer will ultimately be subject to the BEAT, the ECI exception to base erosion payment status is necessary to ensure that the foreign corporation is treated equivalently to a domestic member of its aggregate group receiving deductible payments.

The Treasury Department and the IRS further disagree with the premise that the approaches in the proposed regulations with respect to TLAC interest and section 988 losses support an exception for subpart F or GILTI income in the final regulations. With respect to TLAC, the preamble to the proposed regulations notes that the TLAC exception is appropriate because of the special status of TLAC as part of a global system to address bank solvency and the precise limits that regulations place on the terms of TLAC securities. REG-104259-18, 83 FR 65956, 65963 (December 21, 2018).

With respect to section 988, the preamble to the proposed regulations states that the exception is based on a determination that the losses did not present the same base erosion concerns as other types of losses that arise in connection with payments to a foreign related party.

See

REG-104259-18, 83 FR 65956, 65963 (December 21, 2018).

The Treasury Department and the IRS also disagree with the premise that the approach in the proposed hybrid regulations under section 267A provides support for a regulatory exception. Section 267A(b)(1) expressly provides that the disqualified related-party amount does not include any payment to the extent that the payment is included in the gross income of a United States shareholder under section 951(a). Whereas Congress expressly provided an exception for subpart F in section 267A, Congress did not provide a similar exception for purposes of section 59A. The Treasury Department and the IRS have determined that the inclusion of a similar exception in another section of the Act, but not in section 59A, reflects Congressional intent to not provide a GILTI or subpart F exception for purposes of section 59A. In addition, section 59A(c)(4)(B) provides that a deduction under section 250 (providing a domestic corporation a deduction for a portion of its GILTI amount) is not included in the denominator for purposes of the base erosion percentage; this shows that Congress considered the interaction between section 59A and GILTI, but did not provide an exception from the term base erosion payment for payments subject to tax under section 951A.

Finally, with respect to the suggested GILTI exception, the Treasury Department and the IRS are concerned that a GILTI exception would be difficult to administer because it would require a determination of whether a particular payment to a CFC is included in the taxpayer's GILTI inclusion, but a taxpayer's GILTI inclusion often cannot be traced to particular payments to a CFC because a taxpayer's GILTI inclusion amount depends on multiple factors. A GILTI exception would also need to take into account differences in effective and marginal tax rates under GILTI, BEAT, and regular corporate income tax.

For the foregoing reasons, the final regulations do not provide a regulatory exception to the definition of a base erosion payment for a payment that may give rise to subpart F, GILTI, or PFIC inclusions.

4. Exchange Loss From a Section 988 Transaction

Proposed § 1.59A-3(b)(3)(iv) provides that exchange losses from section 988 transactions described in § 1.988-1(a)(1) are excluded from the definition of base erosion payments. Proposed § 1.59A-2(e)(3)(ii)(D) provides that an exchange loss from a section 988 transaction (including with respect to transactions with persons other than foreign related parties) is not included in the denominator when calculating the base erosion percentage. The preamble to the proposed regulations requests comments on whether the denominator should exclude only section 988 losses with respect to foreign related-party transactions. REG-104259-18, 83 FR 65956, 65963 (December 21, 2018). Comments recommended that section 988 losses should not be excluded from the denominator of the base erosion percentage because excluding all section 988 losses is not consistent with the statute. Some comments, however, recommended that section 988 losses with respect to transactions with foreign related parties that are also excluded from the numerator should continue to be excluded from the denominator, and that this approach would be symmetrical with the approach in the statute for deductions for qualified derivative payments and for amounts eligible for the SCM exception. The final regulations adopt this recommendation.

See

§ 1.59A-2(e)(3)(ii)(D). This approach is also consistent with the treatment of amounts paid to foreign related parties with respect to TLAC securities, which are excluded from the denominator only if the deductions arise from foreign related-party transactions.

5. Exception for Interest on Certain Instruments Issued by Globally Systemically Important Banking Organizations (GSIBs)

Proposed § 1.59A-3(b)(3)(v) provides that the amount paid or accrued to a foreign related party with respect to total loss-absorbing capacity (“TLAC”) securities is not a base erosion payment, but only to the extent of the amount of TLAC securities required by the Board of Governors of the Federal Reserve (Federal Reserve Board) under subpart P of 12 CFR part 252.

See

proposed § 1.59A-1(b)(18) and (20). Specifically, proposed § 1.59A-3(b)(3)(v) provides that the amount excluded is no greater than the amount paid to foreign related parties multiplied by the scaling ratio, which is the average TLAC long-term debt required over the average TLAC security amount. The preamble to the proposed regulations requests comments regarding whether the TLAC exception should also apply to similar instruments issued by foreign corporations that are required by law to issue a similar type of loss-absorbing instruments. These instruments issued by foreign corporations would be relevant for section 59A if interest expense from those instruments is deducted by the U.S. branch or permanent establishment of the foreign corporation. Comments generally supported the exception for amounts paid to a foreign related party with respect to TLAC and suggested that the final regulations expand the exception to foreign issuers.

a. TLAC Issued in Compliance With Foreign Law

Comments requested that the TLAC exception be expanded to include TLAC issued to comply with foreign laws and regulations that are similar to the TLAC requirements prescribed by the Federal Reserve Board. One comment observed that an exception for interest on TLAC that is issued to comply with foreign

law and allocated to a U.S. branch or permanent establishment would provide branch parity, by excluding interest from base erosion payment status to the same extent, whether that internal TLAC debt is issued by a U.S. subsidiary or branch. See generally Rev. Proc. 2017-12, 2017-3 I.R.B. 424, for the definition of internal TLAC.

The Treasury Department and the IRS generally agree with comments that the special status of TLAC as part of the global system to address bank solvency applies equally to TLAC securities whether issued pursuant to U.S. law or foreign law. Consistent with comments, the final regulations expand the scope of the TLAC exception to include internal securities issued by GSIBs pursuant to laws of a foreign country that are comparable to the rules established by the Federal Reserve Board (“foreign TLAC”), where those securities are properly treated as indebtedness for U.S. federal income tax purposes.

2

In order to provide consistency between interest deductions on TLAC of a domestic subsidiary and a U.S. branch or permanent establishment, the final regulations limit the foreign TLAC exception to interest expense of GSIBs, and determine the limitation on the exception by reference to the specified minimum amount of TLAC debt that would be required pursuant to rules established by the Federal Reserve Board for TLAC if the branch or permanent establishment were a domestic subsidiary that is subject to Federal Reserve Board requirements. In addition, to ensure that the limitation is not greater than the amount required under foreign law, the final regulations express the limitation as the lesser of the hypothetical Federal Reserve Board limitation described in the preceding sentence and the specified minimum amount of TLAC debt that is required pursuant to bank regulatory requirements of a foreign country that are comparable to the requirements established by the Federal Reserve Board. Further, the Treasury Department and the IRS understand that in some jurisdictions, foreign TLAC may apply in a more discretionary manner than the framework established in the proposed regulations that references the specified minimum amount of TLAC debt that is required pursuant to rules established by the Federal Reserve Board for TLAC of U.S. issuers, for example, with no specified minimum amount. For that reason, if the bank regulatory requirements of a foreign country do not specify a minimum amount, the limitation is determined by reference solely to the hypothetical Federal Reserve Board limitation. The second prong serves to provide general consistency with TLAC of a domestic subsidiary, by limiting the foreign TLAC exception to no more than the amount of TLAC that would be required by the Federal Reserve Board if the branch were a subsidiary (subject to the modification for a buffer that is also discussed in this Part IV.C.5.b). These rules tend to support the systemic bank solvency goals of TLAC by reducing the tax cost of issuing such securities via foreign related parties. The Treasury Department and the IRS understand that information necessary to determine this amount is generally knowable to banks with U.S. operations. The Treasury Department and the IRS also understand that in some foreign jurisdictions, the foreign TLAC requirements may apply to organizations other than GSIBs; however, to provide general consistency with interest deductions on TLAC of a domestic subsidiary, the final regulations limit the foreign TLAC exception to only GSIBs.

2

While final regulations adopt the comment recommending similar treatment as between TLAC that is required under Federal Reserve Board regulations and similar foreign TLAC instruments, the final regulations do not address, and provide no inference, on whether those instruments issued pursuant to foreign law are treated as debt for U.S. federal income tax purposes.

See

Rev. Proc. 2017-12, 2017-3 I.R.B. 424 (providing generally that the IRS will treat as indebtedness internal TLAC that is issued by an intermediate holding company of a foreign GSIB pursuant to the Federal Reserve Board regulations, and that “[n]o inference should be drawn about the federal tax characterization of an instrument that is outside the scope of [Rev. Proc. 2017-12].”).

b. Buffer Amount Above Specified Minimum Amount

Comments also recommended that the final regulations increase the specified minimum amount of interest eligible for the TLAC exception to permit an additional “buffer” amount of TLAC that exceeds the minimum amount required to satisfy regulatory requirements (such as 115 percent of the specified minimum amount or a buffer equal to 1 to 1.5 percent of the risk-weighted assets). Comments explained that the inputs used to determine the minimum amount of TLAC needed to satisfy regulatory requirements change on a daily basis; as a result, the amount of TLAC securities needed also may change on a daily basis. The comments also noted that market issues dictate a certain lead time to issue TLAC securities. As a result, comments stated that it is the market expectation and practice that GSIBs operate with a buffer, which helps to ensure that TLAC does not fall below the minimum amount when risk-weighted assets or total leverage increase. Finally, the comments asserted that because the cost of issuing TLAC securities significantly exceeds the cost of issuing non-loss absorbing securities, banks are commercially incentivized to issue no more TLAC securities than necessary.

Because of the special status of TLAC as part of a global system to address bank solvency and the specific requirements established by the Board and other regulators, the Treasury Department and the IRS recognize that it is necessary and appropriate to take into account the market practices that have been adopted to prevent TLAC from falling below the specified minimum amount as required by regulations. For these reasons, the final regulations adopt the recommendation to provide a 15 percent buffer on the specified minimum amount of interest eligible for the exception. This buffer applies for both TLAC and foreign TLAC.

c. Requests To Extend the TLAC Exception To Include Other Regulatory Capital Requirements

The Treasury Department and the IRS decline to expand the TLAC exception to cover interest payments on debt to foreign related parties that may satisfy regulatory capital requirements other than TLAC. The TLAC exception was adopted because of the unique role of TLAC securities in the global banking system for GSIBs; while other regulatory capital requirements may also serve an important role in bank regulation, the Treasury Department and the IRS are cognizant that the BEAT applies as a general matter to interest paid to foreign related parties, and have thus limited this regulatory exception to only those specific securities that are issued as part of the integrated international financial regulation and supervision system.

d. TLAC Issued During Transition Period

Comments recommended that the final regulations increase the specified minimum amount of interest eligible for the TLAC exception to permit interest with respect to TLAC debt in place during a three-year transition period before the year in which a corporation is required to have issued TLAC. The final regulations do not extend the TLAC exception to cover TLAC issued during a pre-effective date or transition period before being required to comply with the regulations prescribed by the Federal Reserve Board, because in that situation all of the debt is discretionary rather than mandatory. Further, there is no clear objective metric to scope discretionary issuances during a pre-effective period.

e. Other Operational Elements of the TLAC Exception

A comment recommended modifying the limitation on the exclusion for internal TLAC when a portion of the internal TLAC is held by the U.S. branch of a foreign person such that interest payments on the internal TLAC is also eligible for the ECI exception. The comment recommended that interest on the internal TLAC be first attributed to TLAC held by the U.S. branch of a foreign person, and thus excluded from the definition of a base erosion payment on the basis of the interest being ECI; and then only the incremental interest expense in excess of the amount payable to that branch would be subject to the TLAC scaling ratio limitation. The final regulations do not further expand the TLAC exception through such a rule, so as to retain the narrow scope of the TLAC exception to those securities that are required to be in place because of Federal Reserve Board requirements (taking into account the buffer described in this Part IV.C.5.b). The final regulations clarify the definition of TLAC securities amount to confirm that the TLAC scaling ratio applies without regard to whether TLAC interest is also eligible for another exclusion from base erosion payment status, and thus that the TLAC scaling ratio applies pro-rata to all internal TLAC.

See

§ 1.59A-1(b)(19).

Another comment recommended that the final regulations modify the definition of the “TLAC long term debt minimum amount” to reflect international standards, rather than Federal Reserve Board requirements because the comment asserted that the Federal Reserve Board may, in the future, eliminate the minimum requirement in the Federal Reserve Board regulations. Comments also recommended expanding the TLAC exception to apply to other intercompany debt that is issued to comply with other bank regulatory capital requirements. The Treasury Department and the IRS have determined that it is appropriate to limit the amount of the TLAC exception by reference to Federal Reserve Board requirements, notwithstanding comments suggesting that in the future the Federal Reserve Board may eliminate its minimum required amount. If there are meaningful changes in the total loss absorbing capacity systems in the future, the Treasury Department and the IRS would be able to reassess the section 59A regulations.

Finally, a comment recommended that the final regulations should not exclude interest on TLAC borrowing from the denominator of the base erosion percentage calculation, which is discussed in Part III of this Summary of Comments and Explanation of Revisions. The proposed regulations exclude from the denominator of the base erosion percentage amounts excluded under certain of the specific exceptions to base erosion payment status in § 1.59A-3(b) for SCM, QDP, and TLAC. This is in contrast to those amounts that are not base erosion payments because they are not within the main definition of a base erosion payment, for example, a payment to an unrelated third party, which remain in the denominator. The comment suggested that interest expense that is excluded from the definition of a base erosion payment under the TLAC exception should be viewed as like a payment to an unrelated third party, that is, the interest expense should remain in the denominator of the base erosion percentage. The comment premised this position on the view that internal TLAC should be viewed as issued to the holders of external TLAC (that is, to unrelated third party investors) under a theory that the issuer of internal TLAC is an intermediary or conduit for the issuer of the external TLAC securities. Therefore, there would be no underlying base erosion payment by the U.S. borrower on the internal TLAC, and thus the internal TLAC interest expense would remain in the denominator of the base erosion percentage calculation like interest paid to unrelated third parties. The proposed regulations and the final regulations provide a regulatory exception for internal TLAC on the basis of the special status of TLAC issued by GSIBs as part of the global system to address bank solvency. That is, the rationale for the TLAC exception in the proposed regulations and final regulations is not that the internal TLAC is a conduit for the external TLAC. For this reason, the final regulations (consistent with the proposed regulations) exclude from the denominator the TLAC interest in a manner consistent with the treatment of deductions covered by the SCM and QDP exceptions.

D. Base Erosion Tax Benefits

1. Withholding Tax on Payments

The proposed regulations provide that if tax is imposed by section 871 or 881, and the tax is deducted and withheld under section 1441 or 1442 without reduction by an applicable income tax treaty on a base erosion payment, the base erosion payment is treated as having a base erosion tax benefit of zero for purposes of calculating a taxpayer's modified taxable income and base erosion percentage. If an income tax treaty reduces the amount of withholding imposed on the base erosion payment, the amount of the base erosion payment that is treated as a base erosion tax benefit is reduced in proportion to the reduction in withholding. In the regulation section pertaining to base erosion tax benefits, the final regulations include a technical correction to the fraction used to determine the amount of a base erosion payment that is treated as a base erosion tax benefit when the rate of withholding imposed on that payment is reduced by an income tax treaty. § 1.59A-3(c)(3)(i). To avoid duplication, the final regulation section pertaining to the base erosion percentage replaces a similar operating rule with a cross reference to the rule for determining base erosion tax benefits. See § 1.59A-2(e)(3)(iii).

Under section 884(f) and § 1.884-4, a portion of interest expense allocated to income of a foreign corporation that is, or is treated as, effectively connected with the conduct of a trade or business in the United States (“excess interest”) is treated as interest paid by a wholly-owned domestic corporation to the foreign corporation. The foreign corporation is subject to tax under section 881 on the excess interest and is required to report the excess interest on its income tax return, subject to the exemption provided in section 881 for bank deposit interest and reduction or elimination under applicable tax treaties. However, no withholding is required under section 1441 and 1442.

See

§ 1.884-4(a)(2)(iv). Because no withholding is required, excess interest is not excluded from treatment as a base erosion tax benefit under the proposed regulations.

A comment suggested that because excess interest is subject to tax under section 881(a) as if it were interest paid to a foreign corporation by a wholly-owned domestic corporation, the exclusion from base erosion tax benefits that applies to payments subject to full withholding should also apply to excess interest. The comment suggested that the exclusion from treatment as a base erosion tax benefit might apply to excess interest under the proposed regulations, but requested clarification. While excess interest would not be excluded from treatment as a base erosion tax benefit under the proposed regulations because it is not subject to withholding, the Treasury Department and the IRS have determined that it is appropriate to expand the general exclusion from base erosion tax benefits to include excess interest. Accordingly, the final regulations reduce any base

erosion tax benefit attributable to interest in excess of interest on U.S.-connected liabilities by excess interest to the extent that tax is imposed on the foreign corporation with respect to the excess interest under section 884(f) and § 1.884-4, and the tax is properly reported on the foreign corporation's income tax return and paid in accordance with § 1.884-4(a)(2)(iv). § 1.59A-3(c)(2)(ii). If an income tax treaty reduces the amount of tax imposed on the excess interest, the amount of base erosion tax benefit under this rule is reduced in proportion to the reduction in tax.

The final regulations also provide a coordination rule to clarify the interaction between the withholding tax exception and the rules determining the portion of interest expense attributable to ECI that is treated as paid to a foreign related party. As discussed in part IV.B.4. of this Summary of Comments Explanation of Revisions, interest expense attributable to ECI that is in excess of direct allocations and interest expense on U.S.-booked liabilities is treated as paid to a foreign related party in proportion to the foreign corporation's average worldwide ratio of interest expense paid to a foreign related party over total interest expense. This coordination rule provides that any interest, including branch interest under § 1.884-4(b)(1), on which tax is imposed under 871 or 881 and tax has been deducted and withheld under section 1441 or 1442 but which is not attributable to direct allocations or interest expense on U.S.-booked liabilities is treated as not paid to a foreign related party for purposes of determining the foreign corporation's average worldwide ratio.

2. Rule for Classifying Interest for Which a Deduction Is Allowed When Section 163(j) or Another Provision of the Code Limits Deductions

Section 59A(c)(3) provides a stacking rule in cases in which section 163(j) applies to a taxpayer, under which the reduction in the amount of deductible interest is treated as allocable first to interest paid or accrued to persons who are not related parties with respect to the taxpayer and then to related parties. The statute does not provide a rule for determining which portion of the interest treated as paid to related parties (and thus potentially treated as a base erosion payment) is treated as paid to a foreign related party as opposed to a domestic related party. Proposed § 1.59A-3(c)(4) provides rules coordinating section 163(j) with the determination of the amount of base erosion tax benefits. This rule provides, consistent with section 59A(c)(3), that where section 163(j) applies to limit the amount of a taxpayer's business interest expense that is deductible in the taxable year, a taxpayer is required to treat all disallowed business interest first as interest paid or accrued to persons who are not related parties, and then as interest paid or accrued to related parties for purposes of section 59A. More specifically, with respect to interest paid to related parties, the proposed regulations provide that the amount of allowed business interest expense is treated first as the business interest expense paid to related parties, proportionately between foreign and domestic related parties. Conversely, the amount of a disallowed business interest expense carryforward is treated first as business interest expense paid to unrelated parties, and then as business interest expense paid to related parties, proportionately between foreign and domestic related-party business interest expense.

Proposed § 1.59A-3(c)(4)(i)(C) provides that business interest expense paid or accrued to a foreign related party to which the ECI exception in proposed § 1.59A-3(b)(3)(iii) applies is classified as domestic related business interest expense. One comment observed that the proposed regulations do not expressly provide similar rules for business interest expense paid to foreign related parties that is excluded from the definition of a base erosion payment under the TLAC exception or excluded from the definition of a base erosion tax benefit under the exception for payments subject to withholding tax. The final regulations confirm that those categories of interest expense retain their classification as payments to foreign related parties, but also that the foreign related business interest expense category is treated as consisting of interest that is eligible for these exceptions and interest that is not eligible for these exceptions, on a pro-rata basis.

See

§ 1.59A-3(c)(4)(i)(C)(

2

).

E. Election To Waive Allowable Deductions

See the 2019 proposed regulations for a proposal to provide an election (and certain procedural safeguards) by which a taxpayer may permanently forego a deduction for all U.S. federal tax purposes, with the result that the foregone deduction will not be treated as a base erosion tax benefit.

V. Comments and Changes To Proposed § 1.59A-4—Modified Taxable Income

Proposed § 1.59A-4 contains rules relating to the determination of modified taxable income.

A. Method of Computing Modified Taxable Income

Section 59A(c)(1) defines modified taxable income as “the taxable income of the taxpayer computed under this chapter for the taxable year, determined without regard to—(A) any base erosion tax benefit with respect to any base erosion payment, or (B) the base erosion percentage of any net operating loss deduction allowed under section 172 for the taxable year.” Proposed § 1.59A-4(b)(2) clarifies that modified taxable income is computed by adding back the base erosion tax benefits and base erosion percentage of any net operating loss deductions (the “add-back method”). In addition, to prevent net operating loss benefits from being duplicated, proposed § 1.59A-4(b)(1) provides that taxable income may not be reduced below zero as a result of a net operating loss deduction.

Comments generally recommended one of three approaches to calculate modified taxable income: (1) The add-back method, (2) the “recomputation method,” and (3) the “limited recomputation method.”

1. The Add-Back Method

Some comments recommended that the final regulations retain the add-back method because it would be simpler and easier to administer this method than a recomputation method. See Part V.A.2 of this Summary of Comments and Explanation of Revisions for a description of the recomputation method. Comments highlighted that the add-back method does not require attributes to be separately computed and tracked for regular income tax purposes and the BEAT. In addition, a comment asserted that this method more closely follows the statute, observing that the statutory language in section 59A(c) is substantially different from the recomputation-like language that was in section 59(a)(1)(B) relating to the foreign tax credit determination for alternative minimum tax purposes, which is now repealed for corporations.

See

section 59(a)(1)(B) (providing explicit language referencing computing the alternative minimum tax foreign tax credit as if section 904 were applied on the basis of alternative minimum taxable income instead of taxable income);

see also

the Act, § 12001(a) (repealing the alternative minimum tax for corporations and rendering section 59(a)(1)(B) inapplicable to corporations). Another comment noted that the add-back method is harmonious with the language of section 59A(c)(1)(B) because that section includes the base erosion percentage of net operating loss

deductions as an item included in modified taxable income as the method for determining which portion of net operating loss carryovers from prior years resulted from base erosion tax benefits. (Under a recomputation method with a net operating loss carryover that is computed on a BEAT basis, base erosion tax benefits would already be excluded from the net operating loss carryover, so it would be anomalous to also apply section 59A(c)(1)(B) to the net operating loss deduction.) In support of the add-back method, one comment asserted that applying a recomputation approach would exceed statutory authority.

2. The Recomputation Method

Some comments recommended that the final regulations determine modified taxable income by using the recomputation method that is described in the preamble to the proposed regulations whereby the taxpayer's taxable income is recomputed without the excluded items, or a variation of that method.

See

REG-104259-18, 83 FR 65965 (December 21, 2018) (describing a recomputation approach as requiring attributes that are limited based on taxable income to be recomputed for purposes of section 59A). For example, some comments recommended making the recomputation method elective. One comment requested a recomputation method with a special rule for net operating loss deductions, which is discussed in Part V.A.3 of this Summary of Comments and Explanation of Revisions (limited recomputation method). While comments acknowledged that the add-back method is less complex, comments asserted that the add-back method may result in greater BEAT liability. Comments claimed that the recomputation method more accurately computes the base erosion minimum tax amount (“BEMTA”). Comments also asserted that the language in section 59A(c)—specifically the clause “computed without regard to”—is more consistent with the recomputation method. Another comment noted that nothing in section 59A or its legislative history mandates the use of the add-back method and that taxpayers familiar with the prior corporate alternative minimum tax would have anticipated using the recomputation method.

Additionally, some comments requested a recomputation method with a separate tracking of attributes such as net operating loss carryovers, while others requested a recomputation method without a separate tracking of attributes. Some comments acknowledged that the recomputation method could give taxpayers a double benefit from non-base eroding deductions unless it required separate tracking of attributes for purposes of the BEAT. For example, one comment noted that the recomputation method would generally allow net operating loss carryovers to be used more rapidly for purposes of modified taxable income than for regular tax purposes because the taxable income limitation under section 172 on net operating loss deductions would be lower for regular tax purposes. As a result, the comment noted that if net operating loss carryovers are not separately tracked for purposes of the BEAT, a taxpayer may receive a double benefit from the non-base eroding deductions because those attributes reduce modified taxable income in the loss year, but if the attributes do not reduce the taxpayer's regular tax liability, the attributes would remain available to reduce modified taxable income in a future year. In contrast, another comment asserted that attributes should not be separately tracked because section 59A requires a snapshot of relative tax attributes that are applied independently to calculate taxable income and modified taxable income.

3. The Limited Recomputation Method

Some comments recommended that the final regulations permit a taxpayer to elect to recompute its taxable income with respect to pre-2018 net operating loss carryovers (the “limited recomputation method”). Under this approach, comments generally suggested the taxpayer would use the add-back method except with respect to pre-2018 net operating loss carryovers, which would be separately used and tracked for purposes of the BEAT. One comment suggested that this approach should apply to net operating losses generally, not only pre-2018 net operating loss carryovers. Comments asserted that the proposed regulations have the effect of denying some taxpayers the economic benefit of their pre-2018 net operating loss carryovers because they do not allow pre-2018 net operating loss carryovers to offset full tax liability of taxpayers. Some comments acknowledged that using net operating loss carryovers under any of the three methods discussed in this Part V.A of the Summary of Comments and Explanation of Revisions are timing differences (rather than permanent differences that would deny economic benefit) because pre-2018 net operating loss carryovers are allowed against modified taxable income as and when those net operating loss carryovers are deducted for regular tax purposes. Comments generally asserted that limiting the utilization of net operating loss carryovers is arguably retroactive in nature because it limits the tax benefit of pre-2018 net operating loss carryovers and is unduly harsh because it may cause a taxpayer to pay tax on an amount greater than its economic income. Some comments also asserted that the limited recomputation approach is more consistent with pre-Act section 172 and the policies supporting section 59A. The comments noted that the section 172 legislative history suggests that net operating loss deductions were allowed primarily to alleviate economic losses incurred by taxpayers and asserted that absent clear statutory language and expressed legislative intent to limit the use of net operating losses, taxpayers should be able to use the net operating loss carryovers without limitation in calculating their modified taxable income. However, the comment acknowledged that an attribute tracking system is required to prevent the same net operating loss carryovers from being deducted multiple times for the BEAT.

4. Add-Back Method Retained in Final Regulations

The final regulations retain the add-back method. The add-back method takes into account all the statutory language in section 59A(c)(1), which determines modified taxable income without regard to both the base erosion tax benefits and the base erosion percentage of net operating loss deductions. This approach is also consistent with the Joint Committee on Taxation's Explanation of the Act, which states that “an applicable taxpayer's modified taxable income is its taxable income for the taxable year,

increased by

(1) any base erosion tax benefit with respect to any base erosion payment and (2) the base erosion percentage of any NOL deduction allowed under section 172 for such taxable year.” Joint Comm. on Tax'n, General Explanation of Public Law 115-97 (“Bluebook”), at 403 (emphasis added). By contrast, the recomputation method conflicts with section 59A(c)(1). If taxable income is recomputed without any base erosion tax benefits for modified taxable income, it is a necessary premise that net operating loss carryovers would also be recomputed as BEAT-basis attributes, which, under the recomputation framework, would not include the effect of any base erosion tax benefits (because the recomputation method is without regard to base erosion tax benefits). However, that framework would make the language in section 59A(c)(1)(B)

superfluous or inexplicable because section 59A(c)(1)(B) addresses the percentage of base erosion tax benefits embedded in a net operating loss carryover, whereas a recomputed BEAT-basis net operating loss carryover would already exclude all base erosion tax benefits.

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For example, assume that a domestic corporation (DC) is an applicable taxpayer that has a calendar year. In 2020, DC has gross income of $0, a deduction of $60x that is not a base erosion tax benefit, and a deduction of $40x that is a base erosion tax benefit. For regular tax purposes, DC has a net operating loss carryover within the meaning of section 172(b) of $100x. DC also has a base erosion percentage of 40 percent for the 2020 taxable year. Under the recomputation method, DC's taxable income would presumably be recomputed without regard to base erosion tax benefits, and as a result, DC would presumably have a BEAT-basis net operating loss carryover of $60x, computed as DC's excess of deductions over gross income, without regard to the $40x of deductions that are base erosion tax benefits.

Assume further that in 2021, DC has gross income of $70x, and no current year deductions. For regular tax purposes, DC is permitted a net operating loss deduction of $56x (section 172(a) limits the regular tax deduction for net operating losses that originated after the Act to 80 percent of taxable income before the net operating loss deduction), and thus DC has regular taxable income of $14x ($70x − $56x = $14x). Under the add-back method, DC's modified taxable income for 2021 would be computed as $36.4x, computed as regular taxable income of $14x, plus $0 base erosion tax benefits in 2021, plus the section 59A(c)(1)(B) base erosion percentage of the net operating loss allowed under section 172, $22.4x ($56x × 40 percent = $22.4x).

Under the recomputation method, DC would presumably need to recompute its 2021 taxable income

without regard to

its base erosion tax benefits in 2021 (there are none in the example) and also

without regard to

the base erosion percentage of the net operating loss deduction allowed under section 172 for the taxable year ($56x). Section 59A(c)(1)(B). However, the basic premise of the recomputation method is that DC has a BEAT-basis net operating loss carryover from 2020 of $60x that already excludes the 2020 base erosion tax benefits. DC's modified taxable income for 2021 might thus be computed as $14x ($70x gross income, reduced by $56x, which is the lesser of (i) the $60x BEAT-basis net operating loss carryover from 2020 or (ii) 80 percent of the taxable income ($70x) computed without regard to the section 172 deduction, or $56x). However that adaptation would render section 59A(c)(1)(B) irrelevant. If instead, section 59A(c)(1)(B) was taken into account in computing DC's modified taxable income, then DC's modified taxable income would include the erosion percentage (40 percent) of the BEAT-basis net operating loss carryover from 2020 ($60x), even though that BEAT-basis net operating loss carryover has already been stripped of any 2020 base erosion tax benefits. Thus, this adaptation that gives regard to section 59A(c)(1)(B) would seem to incongruously increase modified t

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