globaltaxnews.ey.comSign up for tax alert emailsForwardPrintDownload |
27 December 2018 US proposed regulations on the Base Erosion and Anti-Abuse Tax (BEAT) under Section 59A have implications for insurance companies On 13 December 2018, the United States (US) Treasury Department (Treasury) and Internal Revenue Service (IRS) issued proposed regulations (REG-104529-18) under Internal Revenue Code1 Section 59A (the Proposed Regulations), providing guidance on the application of the base erosion and anti-abuse tax (BEAT). An overview of Section 59A, and detailed analysis of the Proposed Regulations, can be found in EY Global Tax Alert, US proposed regulations provide guidance on base-erosion and anti-abuse tax under Section 59A, dated 17 December 2018 (the General Alert). Accordingly, terms and concepts used but not defined here generally have the meaning ascribed to them in the General Alert. This EY Tax Alert emphasizes aspects of the Proposed Regulations that are relevant for the insurance industry, including:
Detailed discussionProp. Reg. Sections 1.59A-1 and -2: Determining an applicable taxpayerAs discussed in the General Alert, the Proposed Regulations would clarify the application of the aggregation rules to define an aggregate group and determine the members of that group. The Proposed Regulations would also exclude transactions occurring between members of an aggregate group for purposes of determining the base erosion percentage and the gross receipts of the aggregate group. For any corporation that is subject to tax under subchapter L or any corporation that would be subject to tax under subchapter L if that corporation were a domestic corporation, the Proposed Regulations would allow reducing gross receipts by return premiums, but disallow a reduction for any reinsurance premiums paid or accrued. Consistent with the statute, the Proposed Regulations would require including in both the numerator and denominator of the base erosion percentage certain premiums or other consideration paid or accrued to a foreign related party for reinsurance (discussed in more detail later). The Preamble to the Proposed Regulations clarifies that, with regard to other payments that reduce gross income but are not otherwise base erosion tax benefits (i.e., payments to unrelated parties), such payments “are not included in the denominator of the base erosion percentage.” For example, premiums or other consideration paid to an unrelated party for reinsurance would generally not be included in the denominator of the base erosion percentage to the extent such amounts constitute reductions in gross income under subchapter L instead of deductions. The Proposed Regulations specify that certain other items are not taken into account in the denominator for purposes of the base erosion percentage.2 Under the statute, a 2% base erosion percentage threshold applies to any taxpayer that is a member of an affiliated group (as defined in Section 1504(a)(1)) that includes a domestic bank (as defined in Section 581) or registered securities dealer. The Proposed Regulations would clarify that the term “registered securities dealer” is limited to a dealer as defined in Section 3(a)(5) of the Securities Act of 1934 that is registered, or required to be registered, under Section 15 of the Securities Exchange Act of 1934. Under the Proposed Regulations, if a partnership, or a branch of a partnership, is a registered securities dealer, each partner would generally be treated as a registered securities dealer. An exception exists for partners owning a small interest in the registered securities dealer (taking into account related-party attribution of ownership rules). See the General Alert for a discussion of this exception. The Proposed Regulations provide an exception for an aggregate group that is considered to carry on a de minimis amount of banking and securities dealer activities. Specifically, an aggregate group that includes a bank or registered securities dealer would not be treated as including a bank or registered securities dealer for purposes of applying the base erosion percentage test (and therefore is subject to the general 3% threshold) if the total gross receipts of that group attributable to the bank or registered securities dealer is less than 2% of the total gross receipts of the aggregate group. When there is no aggregate group but a consolidated group that includes a bank or registered securities dealer, the 2% test applies in a similar fashion to the gross receipts of a consolidated group.3 Under the statute, the definition of a base erosion payment includes any premium or other consideration paid or accrued by the taxpayer to a foreign related person for any reinsurance payments that are taken into account under Sections 803(a)(1)(B) or 832(b)(4)(A). The definition of base erosion tax benefits include: (i) any reduction under Section 803(a)(1)(B) in the gross amount of premiums and other consideration on insurance and annuity contracts for premiums and other consideration arising out of indemnity insurance; and (ii) any deduction under Section 832(b)(4)(A) from the amount of gross premiums written on insurance contracts during the taxable year for premiums paid for reinsurance. The Proposed Regulations provide additional guidance on determining the extent to which an item is a base erosion payment, and the amount of such an item that must be taken into account for purposes of the BEAT. The Proposed Regulations generally follow the statute’s definition of base erosion payments related to reinsurance (discussed previously). The Preamble to the Proposed Regulations clarifies that a deductible payment related to reinsurance that does not meet this definition may still be a base erosion payment under the general definition (i.e., generally, a payment for which a deduction is allowable). The Proposed Regulations do not provide specific guidance on payments by a domestic reinsurance company to a foreign related insurance company (e.g., payments for claims for losses incurred). The Preamble to the Proposed Regulations notes that, for a domestic reinsurance company reinsuring the risk of a foreign related party, claims payments for losses incurred and other payments may be deductible and thus potentially base erosion payments (see, e.g., Sections 805, 832(c), and 59A(d)(1)).4 The Preamble observes that, for a non-life insurance company, certain of these payments may also be treated as reductions in gross income under Section 832(b)(3), which are not deductions and also not the type of reductions in gross income described in Sections 59A(d)(3). While the Proposed Regulations do not provide explicit guidance on the treatment of these items, the Preamble states that comments are requested on the “appropriate treatment of these items under subchapter L.” The Preamble also notes that, to the extent certain payments by non-life insurance companies are not treated as deductions, and thus not base erosion payments, this may lead to asymmetric treatment for life insurance companies that reinsure foreign risk. This is because, as noted in the Preamble, part I of subchapter L (the rules applicable for life insurance companies) refers to these costs only as deductions. The Preamble states that comments are requested on “whether the regulations should provide that a life insurance company that reinsures foreign risk is treated in the same manner as a non-life insurance company that reinsures foreign risk.” The Preamble to the Proposed Regulations notes that amounts paid or accrued to a foreign corporation that is treated as a domestic corporation under Section 953(d) are not base erosion payments because such a corporation is treated as a domestic corporation for all purposes of the Code. The Proposed Regulations would confirm that the amount of any base erosion payment is generally determined on a gross basis, and would not permit the netting of amounts owed between the taxpayer and a foreign related party, regardless of any contractual or legal right to do so (e.g., an agreement covering reciprocal payments between the parties that may be settled on a net basis). A notable exception to this gross principle would apply to taxpayers with derivative, security and other financial positions that are marked to market annually. The Proposed Regulations are explicit that all income, gain, loss and deductions must be net into one annual gain or loss for the position, even if there is a technical basis for segregating components of the position into gross amounts. This special rule for mark-to-market items would also apply for the base erosion percentage. As drafted, the Proposed Regulations provide as an example that “any premium or other consideration paid or accrued by a taxpayer to a foreign related party for any reinsurance payments is not reduced by or netted against other amounts owed to the taxpayer from the foreign related party or by reserve adjustments or other returns.”5 The Preamble to the Proposed Regulations states that Treasury and the IRS are aware that certain reinsurance agreements provide that amounts paid to and from a reinsurer are settled on a net basis or netted under the terms of the agreement. The Preamble clarifies that the Proposed Regulations “do not provide a rule permitting netting in any of these circumstances because the BEAT statutory framework is based on including the gross amount of deductible and certain other payments (base erosion payments) in the BEAT’s expanded modified taxable income base without regard to reciprocal obligations or payments that are taken into account in the regular tax base, but not the BEAT’s modified taxable income base.” The Preamble, however, clarifies that, if situations exist in which an application of otherwise generally applicable tax law would compute a deduction on a net basis (because the item reduces the item of deduction rather than increasing gross income), the Proposed Regulations would not change that result. Treasury and the IRS request comments addressing whether a distinction should be made between reinsurance contracts entered into by an applicable taxpayer and a foreign related party that provide for settlement of amounts owed on a net basis. As discussed in the General Alert, the Proposed Regulations would also clarify that a payment or accrual by the taxpayer to a foreign related party may be a base erosion payment regardless of whether the payment is in cash or non-cash consideration (e.g., property, stock or the assumption of a liability). Accordingly, a base erosion payment may occur in the context of a domestic corporation’s acquisition of property from a foreign related party that is subject to depreciation or amortization allowance (e.g., a Section 197 intangible) in exchange for shares of the taxpayer in a non-recognition transaction (e.g., a Section 351 exchange, a Section 332 liquidation, or a Section 368 reorganization). Further, a base erosion payment includes a payment to a foreign related party resulting in a recognized loss (e.g., a loss recognized on the transfer of property to a foreign related party). See the General Alert for a more detailed discussion. As discussed in the General Alert, the Proposed Regulations would helpfully clarify that the SCM exception, with the modifications to the business risk rule contained in the statutory language, is available if there is a markup (and other requirements are satisfied), but that the portion of any payment exceeding the total cost of services — the markup component — is not eligible for the SCM exception and is a base erosion payment. See the General Alert for a detailed discussion. As discussed in the General Alert, a qualified derivative payment would be excluded from being considered a base erosion payment. To qualify, the payment would have to be made pursuant to a derivative, the taxpayer would have to mark the derivative to market and recognize ordinary income, gain, and loss with respect to it, the payment could not otherwise be a base erosion payment (or allocable to a non-derivative component), and certain reporting requirements would have to be satisfied. Prop. Reg. Section 1.59A-6 provides specific guidance on qualified derivative payments, and in particular excludes insurance contracts (e.g., any insurance, annuity or endowment contract issued by an insurance company to which subchapter L applies or would apply if it were a domestic corporation), securities lending and sale-repurchase transactions or any substantially similar transaction from the definition of derivative, with the result that payments on such instruments to a foreign related party would be base erosion payments. As discussed in the General Alert, the Proposed Regulations would exclude from base erosion payments those amounts paid or accrued to a foreign related party that is (or is treated as) effectively connected with a US trade or business (ECI) (or taken into account in determining net taxable income under an applicable US income tax treaty). Therefore, payments to a US branch of a foreign corporation would be excluded from base erosion payments, to the extent that payments to the foreign related party are treated as ECI.6 The Proposed Regulations would not, however, extend the exception to cover payments that constitute subpart F income or tested income of a CFC, even though these amounts may be included in the gross income of a US shareholder as a subpart F income or GILTI inclusion. Exchange losses on Section 988 transactions would not be a base erosion payment under the Proposed Regulations, and, accordingly, would be excluded from the numerator and the denominator of the base erosion percentage. Exchange gains from Section 988 transactions would, however, be included in gross receipts for purposes of the gross receipts test. The Proposed Regulations provide rules for determining the amount of interest expense of a foreign corporation allocable to ECI under Reg. Section 1.882-5 that constitutes a base erosion payment. The Proposed Regulations also provide specific rules on internal dealings under certain income tax treaties. See the General Alert for a detailed discussion. While applicable taxpayer status is determined on the basis of the aggregate group, the Proposed Regulations would confirm that computing modified taxable income (MTI) and the base erosion minimum tax amount (BEMTA) are done on a taxpayer-by-taxpayer basis (treating a consolidated group as a single taxpayer for these purposes). MTI would be computed using an add-back approach, rather than a recomputation method. The Proposed Regulations provide that an NOL deduction cannot result in negative taxable income for purposes of calculating MTI, while a current-year loss results in negative taxable income for computing MTI. See the General Alert for a detailed discussion. The Proposed Regulations would not take into account the limitation in Section 860E(a)(1) (relating to certain interests in real estate mortgage investment conduits or “REMIC”) for purposes of determining the taxable income that is used to compute MTI. As explained in the Preamble, Section 860E(a)(1) generally prohibits a holder of a residual interest in a REMIC from having taxable income less than its excess exclusion amount. As a result of this rule, a holder of a REMIC residual interest may, for example, have taxable income for purposes of computing its regular tax liability despite having a current year loss. The Preamble states that Treasury and the IRS determined that it is not appropriate to apply the rule in Section 860E(a)(1) for the purpose of calculating MTI. The Proposed Regulations contain three anti-abuse rules for certain transactions that have “a principal purpose” of avoiding Section 59A. If any of the proposed anti-abuse rules apply, certain transactions would be disregarded or deemed to result in a base erosion payment. The Preamble to the Proposed Regulations states that the anti-abuse rules address: (i) transactions involving intermediaries acting as a conduit to avoid a base erosion payment; (ii) transactions entered into to increase the deductions taken into account in the denominator of the base erosion percentage; and (iii) transactions among related parties entered into to avoid the application of the rules applicable to banks and registered securities dealers. See the General Alert for a detailed discussion. As discussed in the General Alert, the Proposed Regulations would generally require determinations under Section 59A to be made at the group level, as opposed to each separate entity. See the General Alert for a detailed discussion. Similarly, the Proposed Regulations would amend Reg. Section 1.1502-47(f)(7)(iii) and Reg. Section 1.1502-2, thus, in effect, incorporating the BEAT as a tax included in the computation of consolidated tax liability. The General Alert contains a detailed discussion of general implications of the Proposed Regulations. As it relates to the insurance industry, guidance was provided for determining the gross receipts of an insurance company, and clarification was provided in the Preamble that an amount paid or accrued to a corporation treated as a domestic insurance company under Section 953(d) is not a base erosion payment. No guidance was provided for payments by a domestic reinsurance company to a foreign related insurance company (e.g., claims payments for losses incurred), nor were any specific rules provided that permit the netting of amounts paid to and from a reinsurer under certain reinsurance agreements (absent other guidance in the Code or regulations). Comments are requested on the treatment these items. The Proposed Regulations would require the elimination of transactions between members of the aggregate group, as well as between members of the consolidated group. Additional guidance was provided for the exclusion of certain amounts from either the denominator or numerator of the base erosion percentage. Thus, it is recommended that insurance companies should carefully review the Proposed Regulations to assess whether and/or to what extent they are affected by BEAT, including redetermination of earlier modelling exercises and reanalyzing existing insurance and reinsurance agreements. 1. All “Section” references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder. 3. The elimination of transactions between members of the aggregate or consolidated group should be taken into consideration when determining the gross receipts of the group. 4. Although the Preamble to the Proposed Regulations cites Section 803(c), Section 805 governs deductions for life insurance companies. 6. Payments made to a US branch of a foreign corporation from a related applicable taxpayer would thus be excluded from the numerator of the base erosion percentage, but likewise will be excluded from the denominator (because of the elimination of intra-group transactions). Ernst & Young LLP, Financial Services Office – International Tax Services
Document ID: 2018-6572 |
