US Outbound: BEAT to hit inbound taxpayers hard

27 February 2018

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The new US tax law's base erosion and anti-abuse minimum tax (BEAT) will have a substantial impact on inbound taxpayers. The BEAT provisions require an applicable taxpayer to pay a tax equal to the base erosion minimum tax amount for the tax year. The BEAT amount is the excess of 10% (5% for 2018) of the taxpayer's modified taxable income (MTI) for the tax year over an amount equal to its regular tax liability for that year reduced by certain credits. The MTI is the taxpayer's taxable income increased by its base erosion payments (BEPs).

A BEP is any amount accrued or paid by the taxpayer to a foreign person that is a related party of the taxpayer (determined by 25% affiliation) for which a deduction is allowable (with reductions for amounts subject to gross-basis withholding). The BEPs include deductions arising from depreciable or amortisable assets acquired from such a related foreign person. Exceptions apply for service payments charged at cost with no markup.

The BEPs do not include payments that reduce gross receipts (except for certain companies with respect to which section 7874 is implicated). Therefore, characterisation issues – whether a payment reduces gross receipts or is a payment that is 'deductible' from taxable income – will become very important.

Note also that the BEAT rules would seem more likely to apply to thin-margin taxpayers since a taxpayer with BEPs that reduce its taxable income by more than 50% will be affected by the rule.

In addition, the BEAT rule can produce surprises with respect to interest expense. Assume the US taxpayer has $100 of income for Section 163(j) purposes and has $20 of interest expense owed to both an unrelated bank and a foreign related person. The taxpayer's interest expense deduction is limited to $30. For BEAT purposes the disallowed interest expense is taken from the $20 of the third-party (bank) interest expense. This rule leaves the full $20 of related party interest expense subject to the BEAT calculations.