On 5 September 2018, the United States (US) Treasury and the Internal Revenue Service (IRS) released a draft of Form 8991, Tax on Base Erosion Payments of Taxpayers with Substantial Gross Receipts. Comments may be submitted on the draft form. Although several clarifications are needed, and we recommend certain revisions, the draft form provides some insight into the calculation flow and data required to meet the reporting requirements for the Base Erosion and Anti-Abuse Tax (BEAT) under new Internal Revenue Code Section 59A.¹ In general, this tax applies to cross-border payments made by "Applicable Taxpayers" (generally domestic and foreign corporations that file net-basis income tax returns in the US)² that both: (1) have substantial gross receipts; and (2) reach or exceed a designated base erosion percentage. In general, the form emphasizes a reconciliation approach that requires taxpayers to funnel down from base financial data, while clearly identifying any items that are removed from that data as exceptions. This approach may be challenging for financial services taxpayers to follow in certain areas — e.g., banks that enter into derivatives and broker-dealers that are potentially eligible for the qualified derivative payment (QDP) exception.

Refinements to the draft Form 8991 are expected to be underway in light of proposed regulations scheduled for release in late October or November 2018. In this Tax Alert, we make some observations and highlight areas where clarification may be warranted, particularly for the financial services industry.

Summary of the BEAT

Thresholds

The BEAT introduces a base erosion minimum tax amount (referred to as BEMTA), which represents an incremental tax imposed on payments to foreign related parties made by Applicable Taxpayers with: (i) annual average gross receipts over the prior three years of at least US$500 million;³ and (ii) a base erosion percentage of at least 2% for banks and securities dealers (3% for all other taxpayers) for tax years beginning in 2018. The statute is clear that these two threshold tests should apply at the US-taxpaying group level,⁴ which means that multiple US tax filers (with potentially different tax year-ends) are to be combined in a joint determination.

The second part of the gating threshold, i.e., the base erosion percentage, is a new specifically defined term. It generally refers to the proportion of a US-taxpaying group's total deductions for the year that arise from cross-border, related-party⁵ payments. In general, the base erosion percentage equals a US-taxpaying group's "base erosion tax benefits" divided by its total deductions, with some modification. Base erosion tax benefits are generally US tax deductions that are allowed in the current tax year as a result of payments (or accruals) to foreign related parties. Base erosion tax benefits are a subset of "base erosion payments," a broader term which, among other things, encompasses amounts paid that may have a mix of current- and future-year deductions (e.g., amortizable property purchased from a foreign related party).

BEAT Calculation

If the thresholds are met, Applicable Taxpayers must calculate the BEMTA. The BEMTA ultimately determines an Applicable Taxpayer's liability for BEAT and, for the 2018 tax year, is calculated as follows for a bank or securities dealer:

6%⁶ x modified taxable income (MTI)⁷ — regular tax, as adjusted for certain tax credits

Credits in general, with the exception of research credits (and a portion of other Section 38 credits, such as low-income housing tax credits), do not help taxpayers because they increase the incremental difference between a taxpayer's regular tax liability and base erosion minimum tax. For example, foreign tax credits provide no benefit under the BEAT regime.

Due to the lower applicable BEAT rate in 2018 as compared to the regularly applicable corporate tax rate of 21%, some Applicable Taxpayers may not be subject to BEAT in this transition year. This may not be the case, especially in future tax years, for Applicable Taxpayers with significant non-research tax credits and/or foreign related-party payments that increase MTI.

Special treatment for banks and securities dealers

Although banks and securities dealers must contend with a lower threshold percentage and higher tax rate on MTI, there is an exclusion for related-party payments or accruals on most of the derivatives they employ in their business. Referred to as qualified derivative payments (QDPs), such derivative amounts are entitled to exclusion from the base erosion percentage (both numerator and denominator) and MTI base provided they are of ordinary character, marked-to-market and reported sufficiently on required annual tax forms. The requirement for sufficient QDP reporting of all derivatives to obtain any QDP benefits has caused concern because of the standard's apparent all-or-nothing approach and potential emphasis on quantification.

Form 8991 — summary

The five-page draft Form 8991 emphasizes quantification and contains four parts with two supporting schedules, A and B. While no instructions have been made available yet, there are cross-references throughout the form to enable Applicable Taxpayers to properly flow through consistent inputs, where applicable.

Part I and Schedule A

Part I of the draft Form 8991 documents whether an Applicable Taxpayer is subject to the BEAT based on the gross receipts test and base erosion percentage. For multiple US taxpayers that are presenting data on an aggregated basis, each separate taxpayer must be named and listed, along with its employee identification number (EIN), on an attached schedule to facilitate confirmation of data. Presumably, the list of taxpayers will help the IRS to ascertain whether the 2% or 3% base erosion percentage threshold is appropriate; it would be helpful if future regulations clarified whether any bank or securities dealer in the group is sufficient to reduce the threshold for the entire group, or whether a de minimis rule might apply so that a bank or securities dealer in a group might not reduce the threshold for the entire group if the revenues of the bank or securities dealer were relatively small compared to the group as a whole.

The gross receipts test is presented first; if the $500 million threshold is not met, Applicable Taxpayers may bypass the remainder of the form. Part I, Lines 1, however, must be completed and attached to the taxpayer's tax return indicating that Section 59A does not apply. The same simplified requirement for form completion is not afforded to Applicable Taxpayers meeting the $500 million threshold but not meeting the base erosion percentage threshold, as those taxpayers must attach a detailed accounting of inputs on Schedule A (as well as completing Part I).

Schedule A classifies base erosion payments made during the year for purposes of determining: (i) the numerator of the base erosion percentage, and (ii) total base erosion tax benefits to be added back when computing MTI. Common potential base erosion payments for a financial services company include funding charges, services and derivatives (that are not QDPs). For each payment type, the IRS expects a taxpayer to classify the category of foreign related party (or parties) to whom any such payments are made as a 25% owner of the taxpayer, related under Sections 267(b) or 707(b)(1), and/or related within the meaning of Section 482. There is no quantification required in this section, merely checkmarks.

Parts II — IV and Schedule B

Parts II through IV are to be completed only if the gross receipts and base erosion percentage gating thresholds are passed. Part II lays out the method for determining MTI for purposes of calculating the BEMTA. Part III takes into account the regular tax liability, as adjusted for allowable tax credits under the BEAT regime. The mechanism for adjusting allowable credits is somewhat complex and flows from a three-part calculation in Schedule B. Finally, Part IV calculates whether the tax due on MTI exceeds the adjusted regular tax liability to arrive at the BEMTA.

Form 8991 — specific observations and commentary

Page 1 header

Consistent tax year assumption — The top of the form requests the applicable tax year to be filled in. What date range this should be is unclear for a US-taxpaying group with multiple Applicable Taxpayers that may have different tax year-ends. Japanese- and Canadian-headquartered groups with US operations commonly have at least two US-taxpaying groups in the US, a Form 1120-F filing for the US branch operations and a Form 1120 filing for the US corporate subsidiary group. While the US corporate subsidiary groups often follow a calendar year, US branches of Japanese and Canadian taxpayers typically adhere to a fiscal year ending 3/31 and 10/31, respectively. Indeed, such US branches of Canadian corporations would not even be subject to BEAT until the tax year that starts on 1 November 2018. How and whether their numerical information should be coordinated with the information of their US corporate group already subject to BEAT on a calendar-year basis remains an open matter.

Part I and Schedule A

• Gross receipts quantification — Lines 1a — g: Certain large taxpayers know unequivocally that they meet the gross receipts test without providing a detailed accounting of their average gross receipts based on prior three-year data. As the amount of gross receipts does not flow into any part of the BEAT calculation, perhaps the form could be simplified by allowing large taxpayers to proceed directly to the "Yes" box in Line 1g, skipping Lines 1a — f.
• Allowable deductions pool — Lines 2b and c: When computing their total deductions for purposes of the denominator of the base erosion percentage, Applicable Taxpayers are directed to start with total allowable deductions under Chapter 1 of the Internal Revenue Code on Line 2b. While Chapter 1 covers a very broad range of Code sections that generally should govern all trade or business deductions and losses (including those flowing from partnership investments),⁸ there is nonetheless a catch-all Line 2c that directs taxpayers to include any other allowable deductions. It is not clear what is intended to be included on this line. Further, the schedule does not indicate what data source(s), if any, total allowable deductions (before adjustment) should tie back to.
• Quantification of excepted QDPs — Line 2h:⁹ While the statute calls for a mechanism to identify excepted QDPs, the form of the identification is not specified. Rather than having this required identification take the form of disclosed amounts derived in unknown ways, it may be more beneficial to require taxpayers to lay out their processes for segregating QDPs with foreign related parties from all other QDPs. This requirement would align with similar identification processes found under Section 475(b)(2).
• Base erosion percentage rounding — Part I, Line 2l: Instructions should indicate the rounding convention to be used here so that taxpayers approaching the threshold will know at what point rounding is required. For example, if the rounding convention is two decimal places and a financial services taxpayer calculates a base erosion percentage of 1.9999 pre-rounding, would it be necessary for that taxpayer to round its base erosion percentage up to 2.00, the threshold at which the BEMTA must be computed?
• Pivoting from aggregated threshold data to separate tax filer data — Schedule A, Columns a-1 and -2 vs. Columns b-1 and -2: At first blush, these four columns seem to be requesting input of the same data. Upon further inspection, however, it appears that Columns a-1 and a-2 are intended to show an aggregated US-taxpaying group's data,¹⁰ while Columns b-1 and b-2 are meant to reflect a single US tax-filer's data (e.g., a single federal consolidated filing group).¹¹ Presumably, the accompanying instructions will provide additional guidance with respect to the data required in these columns. For Applicable Taxpayers with a single filing (e.g., many US-parented groups that file a consolidated Form 1120), there may be no difference between the amounts presented in Columns a and b; in those circumstances the form should be simplified to eliminate completing columns with duplicative data.
• Pivoting from base erosion payment to base erosion tax benefit — Schedule A, Column a-1 vs. a-2 and Column b-1 vs. b-2: For both the aggregated data flowing to Part I and the single taxpayer-filing data flowing to Parts II onward, it is not clear why it is necessary to present both base erosion payments and base erosion tax benefits. Only base erosion tax benefits have tax effect currently, as they appear as deductible (or gross-income reducing) amounts on the tax returns of Applicable Taxpayers. Regardless, it is anticipated that these two categories may present the same data in the case of many financial services taxpayers that do not commonly buy depreciable/amortizable property from foreign related parties and who will not often face deferral of deductions for items such as interest under Section 163(j).
• Intended use for reserved lines — Schedule A, Lines 1 and 2: It is unclear what these line items are intended to cover as there is a line for other payments that have not already been specified (i.e., Line 11).
• Consistent representation on related forms — Schedule A, Columns c — e: Depending on which related party boxes are checked, an Applicable Taxpayer should take care to ensure that information is consistently presented on this schedule and other relevant information reporting forms such as Form 5472 and Schedule M of Form 5471.

Parts II — IV

• Carryover of net operating losses (NOLs) — Part II, Lines 3a — d: There has been much discussion around the appropriate treatment of NOLs carried over from prior years in the calculation of MTI. For example, taxpayers have wondered whether MTI may be negative for an Applicable Taxpayer that is able to offset its regular taxable income fully with carried over pre-2018 NOLs. At first blush, negative MTI would not appear to be contemplated in that case as the flow of Part II suggests that the starting point for the calculation may be regular taxable income after reduction for NOLs (i.e., zero per Line 30 of the Form 1120). From there, base erosion tax benefits are identified and presumably added back, suggesting that MTI may be some amount greater than zero.
• Linkage to Forms 1120 and 1120-F — Part IV: Line 5e: Ultimately, the BEMTA result appearing on Line 5e will need to flow through to the Form 1120 or 1120-F, as applicable. A cross-reference should be inserted here and on the face of the appropriate tax filing.

Conclusion

Overall, the draft Form 8991 provides a helpful way for taxpayers to readily identify the specific steps in the BEAT process that are problematic for them in terms of insufficient current guidance or data availability. When considering revisions to the form and related guidance, the IRS will need to balance concerns regarding the availability of data with the requirement to produce reliable and consistent calculations for BEAT purposes. We would expect that the revised Form 8991 would be accompanied by detailed instructions for taxpayers to use as a guide when completing the form. Comments on draft Form 8991 may be submitted at here.

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ENDNOTES

¹ This new Code section was introduced into the US tax law by the Tax Cuts and Jobs Act (TCJA) (H.R. 1), which was signed into law by President Trump on 22 December 2017.

² "Applicable Taxpayers" do not include S corporations, real estate investment trusts (REITs) or regulated investment companies (RICs).

³ Currency references in this Alert are to US$.

⁴ Technically, this aggregation rule treats multiple corporate taxpayers with US tax filing requirements as one if they are commonly controlled (e.g., greater than 50% owned by a common corporate parent).

⁵ For this purpose, a "related party" includes any 25% owner of the Applicable Taxpayer, any person related to the Applicable Taxpayer (or 25% owner thereof) under Section 267(b) or 707(b)(1), and any person considered related under Section 482 (e.g., due to acting in concert to purposefully shift income/deductions, even in the absence of the requisite ownership levels present in the prior two categories).

⁶ The rate is 5% for all other taxpayers in the 2018 tax year. Rates increase significantly in 2019, and again in 2026, for both regular taxpayers and financial services taxpayers.

⁷ MTI is generally the taxable income of a US taxpayer after adding back foreign related-party payments (and adjusting for a percentage of net operating losses (NOLs) utilized in determining taxable income, if applicable).

⁸ Unlike the gross receipts test section of the form (specifically, Line 1b), the base erosion percentage section of the form makes no explicit reference to whether or how partnership investment data (e.g., interest expense flowing from a partnership to a US corporate taxpayer) should be included in an Applicable Taxpayer's deduction pool. We would expect proposed regulations to provide guidance in this area.

⁹ Note that Line 2h of Part I appears to be a missing cross-reference to Schedule A, Line 9b.

10. As can be seen by the cross-references to and from Part I for Column a-2.

¹¹ Treasury may intend, in proposed regulations, to apply an aggregation rule for determining whether taxpayers meet the threshold tests and a single filer rule for computing the BEAT, thus requiring the data to be presented in this manner, though this result is far from clear.

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CONTACTS

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, FSO, International Tax Services, New York

• Lauren Lovelace
  lauren.lovelace@ey.com
• Chris Ocasal
  chris.ocasal@ey.com
• Lauren Tanenbaum
  lauren.tanenbaum@ey.com

Ernst & Young LLP, International Tax Services, Washington, DC

• Arlene Fitzpatrick
  arlene.fitzpatrick@ey.com

Ernst & Young LLP, International Tax Services, New York

• Stephen Jackson
  steve.jackson@ey.com

Washington Council Ernst & Young

• Jeff Levey
  jeff.levey@ey.com

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ATTACHMENT

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