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December 11, 2019

We Got the BEAT: The IRS Issues Final and New Proposed

Base Erosion and Anti-Abuse Tax Regulations

By Mark Leeds & Lucas Giardelli

The Go-Go’s were a unique early 1980s pop

band because it was comprised solely of

women who wrote, as well as performed, their

own music. Their style was groundbreaking

and defined what came to be known as the

“new wave.” And the songs were very catchy.

When the base erosion and anti-abuse tax

(commonly known as the “BEAT”) was added

to Section 59A of the Internal Revenue Code

of 1986, as amended (the “Code”) at the end

of 2017, it too heralded a new wave . . . of

taxation. Just like we’re always looking to hear

what’s next from our favorite musicians, the

tax bar has been feverishly anticipating more

BEAT guidance. Luckily for us, on December 2,

2019, the US Internal Revenue Service (the

“IRS”) issued final regulations interpreting the

BEAT rules

(the “Final Regulations”) and

promulgated new proposed regulations (the

“2019 Proposed Regulations”) offering

additional opportunities for affected taxpayers

to address BEAT issues.

The Final Regulations apply to 2019 tax years.

For 2018 tax years, taxpayers may elect to

apply the Final Regulations or the 2018

Proposed Regulations, so long as either set of

regulations is applied in its entirety. Taxpayers

may also rely on the 2019 Proposed

Regulations for 2018 and subsequent tax

years so long as such rules are also applied in

their entirety.

I. Background

The BEAT functions as a minimum tax in that it

only applies if a taxpayer’s liability under the

BEAT (referred to as “base erosion minimum

tax amount” or “BEMTA”) exceeds its regular

tax liability.

The BEAT is applicable only to

taxpayers with 3-year average annual gross

receipts of at least $500 million and then only

if their “base erosion percentage” exceeds a

specified threshold (3% for taxpayer groups

without domestic banks and securities dealers

and 2% for groups with domestic banks

and/or securities dealers that generate more

than a de minimis amount of income).

Although the BEAT potentially applies to all

large taxpayers, it is likely to have significant

application to banks and insurance

companies.

The BEAT adds back most payments made by

US taxpayers and US branches of non-US

taxpayers to their non-US affiliates (that is,

non-US persons connected through 25% or

greater common ownership) to taxable

income to arrive at “modified taxable

income.”

The BEAT is then applied to this

modified taxable income and, if this tax

exceeds the taxpayer’s regular tax, the excess

or BEMTA is owed as an additional tax.

The first step in determining whether the BEAT

applies to a particular taxpayer is to ascertain

whether the taxpayer is an “applicable

taxpayer.”

A taxpayer will be treated as an

applicable taxpayer if it meets three tests:

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1. The taxpayer must be a corporation, but

not a regulated investment company, a

real estate investment trust or an S

corporation;

2. The taxpayer must have aggregate

average gross receipts for the preceding

three years of at least $500 million; and

3. The taxpayer’s base erosion percentage

for the taxable year must be 3% or higher

(2% in the case of US banks and registered

securities dealers).

Special, and fairly complex, rules apply to

determine whether the second and third tests

are satisfied, including calculations on an

“aggregate group” basis.

If a taxpayer meets the definition of an

applicable taxpayer, the application of the

BEAT provisions begins with the determination

of “modified taxable income.” Modified

taxable income is taxable income determined

without regard to any “base erosion tax

benefit” with respect to any “base erosion

payment.”

A base erosion payment includes

any amount paid or accrued by the taxpayer

to a related foreign person and with respect to

which a deduction is allowable. In general, a

foreign person will be treated as a related

party if there is a 25% or greater ownership

overlap with the taxpayer. A base erosion tax

benefit includes a deduction that is allowed

with respect to a base erosion payment.

Base erosion tax benefits generally include

deductible payments for services, interest,

rents and royalties. Depreciation and

amortization deductions with respect to

property acquired from related foreign

persons may also be considered base erosion

tax benefits and be disregarded in

determining modified taxable income. No

amount is generally added back in

determining modified taxable income for

payments to foreign related persons that are

not deductible, but instead reduce gross

income, e.g., amounts included in cost of

goods sold. Base erosion payments do not

include “qualified derivative payments” within

the meaning of Code § 59A(h) or payments

made by a US taxpayer for services that may

be accounted for on the “services cost

method” under Code § 482 to the extent such

amount constitutes the total services cost

without mark-up.

The BEAT rate varies by year and by whether

the taxpayer is a US bank or a registered

securities dealer. Specifically, the BEAT rate is

10% in 2019 through 2025 and 12.5%

thereafter.

These rates are increased by one

percentage point for US banks and registered

securities dealers.

II. Threshold Issue – The

Determination of Gross Receipts

As noted above, only taxpayers with average

annual gross receipts of at least $500 million

(measured on an “aggregate group” basis) are

subject to the BEAT.

Following the 2018

Proposed Regulations, the Final Regulations

generally define “gross receipts” by reference

to Code §448(c)(3) and the regulations

thereunder.

Thus, gross receipts include total

sales (net of returns and allowances), all

amounts received for services and income

from investments. Gross receipts are not

reduced by cost of goods sold and do not

include repayment of a loan (notably,

however, gross receipts would generally

include the gross proceeds from the sale of a

loan by a bank).

III. Aggregate Group Calculations

Code § 59A determines the status of a

corporation as an “applicable taxpayer” by

measuring gross receipts and the base erosion

percentage by reference to the corporation’s

“aggregate group.” A question arises as to

how these items should be measured when

members of the aggregate group have

different taxable years than the tested

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taxpayer. The 2018 Proposed Regulations

provided that 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 the

aggregate group during such taxable year

(regardless of such other members’ own

respective taxable years). This approach raised

administrability concerns because many

companies do not maintain detailed monthly

accounting records. Heeding this concern, the

Final Regulations change to a “with-or-within

method”: the gross receipts and base erosion

percentage are calculated on the basis of the

tested taxpayer’s taxable year and the taxable

year of each member of its aggregate group

that ends with or within the tested taxpayer’s

taxable year.

The Final Regulations clarify that a transaction

between members of the same aggregate

group is disregarded when determining the

gross receipts and base erosion percentage,

so long as both parties were members of the

same aggregate group at the time of the

transaction. It is irrelevant whether the parties

were members of the same group on the last

day of the taxpayer’s taxable year.

addition, for purposes of calculating the base

erosion percentage, the Final Regulations

exclude deductions attributable to a taxable

year of a member that began before January

1, 2018.

Treasury also addressed certain mechanical

aspects of the aggregate group calculations in

the 2019 Proposed Regulations. Recognizing

that the existing rules may lead to over- or

under-counting in the case of taxpayers with

short taxable years, the 2019 Proposed

Regulations would require such taxpayers to

use a “reasonable approach” in determining

the base erosion percentage and gross

receipts of their aggregate group.

The 2019

Proposed Regulations would also provide that,

in the case of members that join or leave the

aggregate group, only items accrued during

the period they were members shall be taken

into account.

IV. Mark-to-Market Transactions

As discussed above, a taxpayer will be subject

to the BEAT only if its base erosion percentage

exceeds 3% (2% for aggregate groups that

include domestic banks or broker dealers). The

fraction compares base erosion tax benefits

(the numerator) with the aggregate amount of

deductions (the denominator).

Deductions

for mark-to-market losses increase the

denominator of the fraction and are therefore

helpful to taxpayers in avoiding breaching this

threshold. The Final Regulations retain an

unfavorable rule, however, for determining

mark-to-market losses. Although under

general mark-to-market accounting, income

earned on a position is not taken into account

in determining the mark-to-market

adjustment,

such items are netted against

the amount of loss that may be added to the

denominator of the base erosion

percentage.

Accordingly, if a taxpayer

receives a $10x interest payment on a debt

instrument and has a $100x mark-to-market

loss with respect to such debt instrument at

the end of the year in which the payment is

received, only $90x of losses are added to the

denominator of the base erosion percentage.

V. Base Erosion Payments

There are generally three types of payments

that when made by a US taxpayer (including a

US branch of a non-US corporation) to a

foreign related party are treated as base

erosion payments: (i) deductible payments, (ii)

a payment for the acquisition of depreciable

or amortizable property, (iii) reinsurance

premiums.

The Final Regulations clarify that

other reductions to gross income (including

cost of goods sold) are not base erosion

payments.

The question as to whether a

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payment or accrual is deductible is made

under general federal income tax principles.

The Final Regulations prescribe that general

federal income tax principles (including the

assignment of income, agency, reimbursement

and conduit doctrines) shall be applied first to

characterize a payment when determining

whether such payment is considered a base

erosion payment. For example, if a US

taxpayer reimburses its foreign affiliate for

depreciable supplies purchased from an

unrelated party under a common paymaster

arrangement, the payment to the foreign

affiliate should not be viewed as a base

erosion payment. The US taxpayer is not

acquiring property from the foreign affiliate in

this case; it should be viewed as having

acquired the property directly from the

unrelated vendor. Concomitantly, if a US

taxpayer makes a deductible payment to a

foreign affiliate that is acting as an agent or a

conduit for the US taxpayer to pay an

unrelated party, the payment should not be

considered to be a base erosion payment. The

preamble to the Final Regulations cautions

taxpayers, however, that payments to foreign

affiliates will not be considered to be conduit

payments merely because the foreign affiliate

makes a corresponding payment to a third

party. Taxpayers must apply existing case law

to the facts and contractual relationships

involved in a given payment to establish that

the payment is being made to an affiliate as a

conduit.

According to the preamble to the 2018

Proposed Regulations, a base erosion

payment would have included a loss

recognized on the transfer of property to a

foreign related party (e.g., if a taxpayer

transfers built-in loss property to a foreign

related party as a payment for goods or

services). Commentators rejected this idea

noting that, in those cases, the loss deduction

is not properly attributable to the payment,

but rather to the taxpayer’s basis in the built-

in loss property. Adopting these comments,

the Final Regulations clarify that a loss realized

from the transfer of property to a foreign

related party is not itself a base erosion

payment. To the extent the transfer of

property was the form of consideration for a

base erosion payment, the amount of the base

erosion payment will be limited to the fair

market value of the transferred property.

The Final Regulations adopt the exception in

the 2018 Proposed Regulations for the cost

component of amounts paid for services that

are eligible for the SCM exception under

Treas. Reg. §1.482-9. In other words, the

tempest in a teapot over whether services will

cease to be eligible for the exception if a

mark-up is charged has been favorably

resolved. The Final Regulations further

elaborate on the documentation that

taxpayers must maintain to validly rely on this

exception.

Following the issuance of the 2018 Proposed

Regulations, one of the most sought after

changes was the inclusion of an exception to

the definition of base erosion payments for

payments made by a US corporation to a CFC

are not treated as base erosion payments to

the extent they result in Subpart F income or

GILTI. The Final Regulations decline to include

such an exception.

The 2018 Proposed Regulations provided that

exchange losses from a Code § 988

transaction were excluded from the definition

of base erosion payments. Further, all such

exchange losses (including those resulting

from transactions with persons other than

foreign related parties) were excluded from

the denominator when calculating the base

erosion percentage. In a taxpayer-friendly

change, the Final Regulations only exclude

from the denominator exchange losses that

result from Code § 988 transactions with

foreign related parties (that is, those also

excluded from the numerator).

Other

exchange losses would be included in the

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denominator, thus helping reduce the base

erosion percentage.

The Final Regulations offer good news for the

insurance industry. If a US reinsurer makes a

claims payment to a non-US insurer, the

payment is not treated as a base erosion

payment to the extent that the non-US insurer

itself has an obligation to pay a claim.

If,

however, a US insurer makes a premium

payment to a non-US reinsurer and the non-

US insurer retrocedes the risk to a third party

reinsurer, there is no look-through or netting

of the initial reinsurance payment.

VI. Deduction Waivers

The 2019 Proposed Regulations allow

taxpayers to selectively waive deductions that

could be treated as base erosion payments.

A waived deduction is not a base erosion

payment and therefore is excluded from the

computation of the base erosion percentage

and is not added back in determining

modified taxable income.

Deductions can be

waived even during a tax audit.

The amount

of waived deductions can be adjusted

upwards but not downwards. The election to

waive deductions would not constitute a

method of accounting under Code §446, and,

accordingly, no IRS consent is required.

Detailed rules are provided regarding the

effect of the waiver on earnings and profits,

transfer pricing and the ability to claim tax

credits.

VII. Global Dealing and Profit Split

Arrangements

The preamble to the Final Regulations

acknowledges that global dealing, that is,

when multiple taxpayers all book transactions

into the same ledger account, does not give

rise to base erosion payments even when a US

taxpayer makes a payment to a foreign

affiliate pursuant to such an arrangement.

However, the IRS desired to leave open its

ability to challenge such a position when the

contractual arrangements among the parties

create deductible payments in connection

with such a dealing operation. For this reason,

the Final Regulations do not contain a blanket

rule that exempts payments made in

connection with global dealing operations

from being considered base erosion

payments. For the same reason, payments

made by US taxpayers pursuant to profit split

arrangements (while acknowledged as

avenues not giving rise to base erosion

payments) are not carved out from the

definition of such payments.

In other contexts, the preamble to the Final

Regulations specifically acknowledges that the

apportionment of expenses does not give rise

to base erosion payments.

VIII. Netting

The Final Regulations do not permit the

taxpayer to net payments to and from foreign

affiliates in determining the amount of any

base erosion payment, except to the extent

that netting is permitted or required under

other provisions of the Code or federal

income tax principles.

This rule applies even

if the contractual relationship between the

taxpayer and the foreign affiliate permits

netting. For example, if a US taxpayer makes a

$100x payment to a foreign affiliate under an

intercompany agreement and the foreign

affiliate makes a $40x to the US taxpayer

pursuant to another intercompany transaction,

the base erosion payment is $100x, not $60x

($100x - $40x). The inability to net payments

will, of course, increase both the likelihood

that a US taxpayer will breach the base

erosion percentage and that the BEAT will

apply. Interestingly, the IRS specifically

declined to provide guidance on swap

(notional principal contract) transactions. IRS

regulations specifically provide for netting

swap payments.

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IX. Acquisitions of Property in

Nonrecognition Corporate

Transactions and Distributions

One of the most controversial aspects of the

2018 Proposed Regulations involved the

acquisition by a domestic corporation of

depreciable or amortizable property from a

foreign related person in a nonrecognition

transaction (i.e., a Code § 351 contribution, a

Code § 332 liquidation, a Code § 368

reorganization). Under the 2018 Proposed

Regulations, these types of corporate

nonrecognition transactions were viewed as

involving base erosion payments and, as a

result, the depreciation and amortization

deductions subsequently claimed by the

domestic corporation would be characterized

as base erosion tax benefits. This rule was met

with several objections. Comments argued

that these transactions should not give rise to

base erosion payments because they do not

involve an actual “payment.” Further, it was

noted that the rule provided a disincentive to

the on-shoring of intangible and other

income-producing property, contrary to the

goals of the Tax Cuts and Jobs Act.

Consistent with the comments, the Final

Regulations exclude from the definition of a

base erosion payment amounts transferred to,

or exchanged with, a foreign related party in a

corporate nonrecognition transaction.

Any

“boot” exchanged in such transactions,

however, is treated as a base erosion

payment.

For example, if a non-US

corporation transfers depreciable or

amortizable property to its wholly-owned US

subsidiary in a Code §351 transfer and the

non-US parent receives common stock and

cash in exchange, the cash may be treated as

a base erosion payment, while the common

stock is not.

Notwithstanding the above, the Final

Regulations include an anti-abuse rule to

tackle situations where the general exclusion

for nonrecognition transactions is viewed as

presenting inappropriate results. If there is a

plan or arrangement that has a principal

purpose of increasing the adjusted basis of

certain property in anticipation of the

acquisition of such property in a

nonrecognition transaction, the exclusion will

not apply. Such principal purpose will be

deemed to exist if a transaction between

related parties increases the adjusted basis of

the property within six months prior to the

taxpayer acquiring the property in a

nonrecognition transaction.

The Final Regulations also clarify the

treatment of depreciable or amortizable

property that a shareholder may acquire from

a corporation in a distribution transaction. A

“pure” Code § 301 distribution for which there

is no consideration is not treated as giving rise

to a payment by the shareholder to the

corporation. In contrast, such a payment will

be deemed to exist when a corporation

redeems stock in exchange for property. As a

result, if a US corporation acquires property

from a foreign subsidiary in a stock

redemption transaction, the amortization or

depreciation deductions claimed with respect

to the property may be subject to the BEAT.

X. Interest Expense

The BEAT applies to non-US corporations that

have income that is subject to net income

taxation in the United States as income

effectively connected with the conduct of a US

trade or business (“ECI”). In other words, the

BEAT generally applies to non-US

corporations with a US branch. Subject to the

application of the “treaty method” for

taxpayers that are entitled to the benefits of

an income tax treaty, a foreign corporation

generally determines the interest expense

allocable to its US branch under one of two

sets of rules: the Adjusted US Booked Liability

(“AUSBL”) method or the Separate Currency

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Pool (“SCP”).

A foreign corporation that has

interest expense allocable to its US branch will

have a base erosion payment to the extent the

interest expense allocable to the branch is

treated as paid to a foreign related party.

The 2018 Proposed Regulations laid out

different rules to determine the extent to

which interest expense allocable to a US

branch would be treated as paid to a foreign

related party depending on whether the

foreign corporation used the AUSBL or SCP

method.

Commentators had noted that the

methods in the 2018 Proposed Regulations

may produce meaningfully different amounts

of base erosion payments depending on

which method the taxpayer uses to determine

its branch interest expense under

Treas. Reg. §1.882-5—specifically, that

taxpayers using the AUSBL method would

generally experience a lower amount of base

erosion payments than taxpayers using the

SCP method. These comments argued that the

difference was not supported by tax policy

and requested changes to achieve consistent

results.

The Final Regulations change the rules to

achieve consistency between AUSBL and SCP

taxpayers and eliminate the negative impact

of the proposed rule on taxpayers using the

SCP method. Under the Final Regulations, for

taxpayers using either method, the amount of

US branch interest expense treated as paid to

a foreign related party shall be the sum of (1)

the directly allocated interest expense paid to

a foreign related party, (2) the interest

expense on US-booked liabilities actually

owed to foreign related parties, and (3) the

interest expense on US-connected liabilities in

excess of US-booked liabilities multiplied by

the ratio of average foreign related-party

interest over average of total interest

(excluding from this ratio interest expense on

US-booked liabilities and interest expense

directly allocated).

The Final Regulations also

introduce a simplifying election allowing a

taxpayer to determine its worldwide interest

ratio based on its applicable financial

statements instead of US tax principles.

The Final Regulations also change the

calculation of base erosion payments for

foreign corporations that determine the

interest expense attributable to their US

permanent establishment under an income tax

treaty.

The foreign corporation will

nonetheless first need to determine the

hypothetical amount of interest expense that

would have been allocated to the permanent

establishment under the Treas. Reg. §1.882-5

methodology (but not in excess of the amount

of interest expense attributable under the tax

treaty). The “hypothetical 1.882-5 interest

expense” is treated in a manner consistent

with the rules described above (i.e., to the

extent that such hypothetical expense is

considered paid to foreign related parties,

such interest expense is treated as a base

erosion payment). Interest expense in excess

of the hypothetical §1.882-5 interest expense

is treated as paid by the US permanent

establishment to the home office or another

branch of the foreign corporation, thus

constituting a base erosion payment.

In addition, the Final Regulations provide that

“excess interest” shall not be treated as a base

erosion payment to the extent it is subject to

the “branch level interest tax” under Code

§884(f)(1). Accordingly, if an income tax treaty

reduces the amount of tax imposed on excess

interest, the amount of the base erosion tax

benefit is reduced proportionately.

XI. Hedging

Commentators had lobbied for an exception

to the definition of base erosion payments for

payments pursuant to a transaction treated as

a hedge for federal income tax purposes. The

IRS denied this request on the ground that

neither the statute nor the legislative history

provided for any such exception.

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XII. Qualified Derivatives Payments

Qualified derivative payments (“QDPs”) made

by affected taxpayers to foreign affiliates are

excluded from the definition of base erosion

payments.

The Final Regulations track the

statute in defining a QDP: (i) the affected

taxpayer must use mark-to-market accounting

for such derivative, (ii) all recognized gain on

the derivative must be ordinary in character

and (iii) payments made on the derivative

must give rise to ordinary gain or loss.

Derivatives for this purpose do not include

sale-repurchase transactions.

In a surprise

reversal from the Proposed 2018 Regulations,

the Final Regulations treat borrow fees paid in

securities lending transactions as QDPs.

However, securities lending transactions

structured to essentially replicate cash

borrowings with the intent to avoid a base

erosion payment will not be treated as giving

rise to QDPs.

XIII. Total Loss Absorbing Capacity

(“TLAC”) Payments

TLACs are securities that regulators require

globally systemically important banks

(“GSIBs”) to issue to be written off or

converted into common stock if the bank

experiences financial difficulties. Frequently,

US branches and US subsidiaries of non-US

banks issue TLACs to their foreign parent,

creating an issue as to whether interest

payments on the TLACs are base erosion

payments. The 2018 Proposed Regulations

had introduced an exception such that interest

payments made on TLAC securities are not

treated as base erosion payments. The Final

Regulations retain and expand this

exception.

First, recognizing that banks frequently issue

more TLACs than are actually required in order

to hedge against a potential shortfall in their

minimum TLAC requirement, the Final

Regulations provide a 15% buffer on the

specified minimum amount of interest eligible

for the exception. As such, interest on up to

115% of the amount of required TLACs may

be excluded from being treated as base

erosion payments.

Second, the Final Regulations expand the

scope of the TLAC exception to include

securities issued by GSIBs pursuant to laws of

a foreign country that are comparable to the

rules established by the Federal Reserve Board

in the US.

The exception for “foreign TLAC

securities” will be limited to interest on 115%

of the lesser of (i) the specified minimum

amount of TLAC debt required by the foreign

regulator or (ii) the minimum amount that

would be required if the branch were a US

subsidiary subject to the Federal Reserve

Board rules.

Internal TLACs are often issued in back-to-

back structures in which the US branch or

subsidiary issues TLACs to the foreign parent

and the foreign parent issues TLACs to the

market. In these circumstances, and assuming

the foreign parent is not a conduit under

general federal income tax principles, the Final

Regulations exclude the US branch interest

payment from both the numerator and the

denominator when computing the base

erosion percentage.

Taxpayers had

requested that, in all cases, the IRS permit the

US internal TLAC issuer to “look-through” the

internal holder to the unrelated persons who

held the TLACs issued by the foreign parent,

such that the US taxpayer could include the

interest deductions corresponding to such

TLACs in the denominator. The IRS declined to

issue such a rule.

XIV. Computation of Modified

Taxable Income

Code §59A(c)(1) defines “modified taxable

income” as the taxable income of the

corporation determined without regard to any

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base erosion tax benefits and to the base

erosion percentage of any net operating loss

(“NOL”) deduction allowed for the taxable

year. The 2018 Proposed Regulations provided

that modified taxable income would be

determined under the “add-back method,”

that is, following a static approach where the

base erosion tax benefits are simply added

back to the taxable income determined under

the applicable rules of the Code. In doing so,

the 2018 Proposed Regulations rejected a

dynamic “recomputation method” where the

disallowance of a deduction under BEAT

would, for example, result in an increased

capacity to utilize NOLs under Code §172 or

an increased “adjusted taxable income” under

Code §163(j). The Final Regulations retain the

add-back method, noting in the preamble that

the approach is consistent with the statutory

language and simpler to administer than a

recomputation method.

If, however, current taxable income is a

positive number and the taxpayer has a net

operating loss (“NOL”) carryover, taxable

income is floored at zero.

NOLs arising

before 2018 may be claimed without

limitation. NOLs arising in 2018 and after must

be reduced by the base erosion percentage

applicable to such NOL.

The base erosion

percentage is based upon the year in which

the NOL arose, not the year in which it is

utilized.

In addition, if the taxpayer is part of

an aggregate group, the base erosion

percentage of an NOL is determined based on

the group’s base erosion percentage.

XV. Application to Partnerships

The Final Regulations adopt an aggregate

approach to characterize payments made or

received by a partnership for purposes of the

BEAT.

This is consistent with the approach

taken the 2018 Proposed Regulations. The

Final Regulations provide a more detailed

explanation of the mechanics of this

aggregate approach, together with illustrative

examples. In this respect:

 If depreciable or amortizable property is

transferred to a partnership, each partner is

treated as receiving its proportionate share

of the property for purposes of determining

if it has a base erosion payment. Similarly, if

depreciable or amortizable property is

transferred by a partnership, each partner is

treated as transferring its proportionate

share of the property.

 If a person transfers a partnership interest,

the transferor is generally treated as

transferring its proportionate share of the

partnership’s assets. When a partnership

interest is transferred by the partnership

itself, each partner whose proportionate

share of assets is reduced is treated as

transferring the amount of such reduction.

The preamble to the Final Regulations clarifies

that there is no exception for nonrecognition

transactions involving partnerships. Consistent

with the aggregate approach, partners are

treated as engaging in transactions directly

with each other and not with the partnership

as a separate entity. For example, if a US

corporation and a foreign related party each

contribute depreciable property to a new

partnership in exchange for partnership

interests in a Code § 721(a) exchange, the

transaction is treated as a partner-to-partner

exchange that may result in a base erosion

payment for the US corporation.

The Final Regulations retain the “small partner

exception” from the 2018 Proposed

Regulations for payments made by a

partnership. A partner is not required to take

into account its distributive share of any base

erosion tax benefit that result from the

partnership’s payment if the partner’s interest

(i) represents less than 10% of the capital and

profits of the partnership, (ii) represents less

than 10% of each item of income, gain, loss,

deduction and credit, and (iii) has a fair market

value of less than $25 million.

10 Mayer Brown | We Got the BEAT: The IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax

Regulations

Finally, the preamble to the 2019 Proposed

Regulations requests comments regarding the

application of the BEAT to partnerships,

including as it relates to partnerships that

have ECI.

XVI. Anti-Abuse and

Recharacterization Rules

The Final Regulations retain the anti-abuse

and recharacterization rules from the 2018

Proposed Regulations relating to (i)

transactions involving intermediaries acting as

a conduit if there is a principal purpose of

avoiding a base erosion payment, (ii)

transactions with a principal purpose of

increasing the deductions in the denominator

of the base erosion percentage, and (iii)

transactions among related parties entered

into with a principal purpose of avoiding the

application of the special rules for banks and

registered securities dealers. In addition, as

explained above, the Final Regulations add a

new anti-abuse rule for (iv) transactions with a

principal purpose of increasing the adjusted

basis of certain property in anticipation of the

Mark Leeds is a partner and Lucas Giardelli is a senior

associate in the New York office of Mayer Brown. Mark will

be presenting on the Final BEAT Regulations at the

International Bar Association Annual Finance & Capital

Markets Tax Conference in London on January 21, 2020.

Lucas will be presenting on the Final BEAT Regulations at

the American Bar Association meeting in Boca Raton, FL,

on January 31, 2020.

The Final Regulations replace proposed regulations that

were issued in December 2018 (the “2018 Proposed

Regulations”). For a discussion of the 2018 Proposed

Regulations, please see

https://www.mayerbrown.com/en/perspectives-

events/publications/2019/01/irs-issues-proposed-

regulations-implementing-base.

Treas. Reg. § 1.59A-10.

Code § 59A(b).

acquisition of such property in a

nonrecognition transaction.

The Final

Regulations add new examples illustrating the

application of these anti-abuse rules.

For more information about the topics raised

in this Legal Update, please contact any of the

following lawyers or any other member of our

Tax and Tax Controversy practice.

Michael Lebovitz

+1 213 229 5149

mlebovitz@mayerbrown.com

Mark H. Leeds

+1 212 506 2499

mleeds@mayerbrown.com

Gary Wilcox

+1 202 263 3399

gwilcox@mayerbrown.com

Lucas Giardelli

+1 212 506 2238

lgiardelli@mayerbrown.com

Code § 59A(e); Treas. Reg. § 1.59A-2(e).

Code § 59A(c).

Code § 59A(a).

Code § 59A(e)(1).

Code § 59A(c).

Code § 59A(d)(5).

Code § 59A(b).

Code § 59A(b)(3).

Code §59A(e)(2)(B).

Treas. Reg. §1.59A-1(b)(13).

Treas. Reg. §1.59A-2(c)(3).

Treas. Reg. §1.59A-2(c)(1).

Treas. Reg. §1.59A-2(c)(8).

Prop. Treas. Reg. §1.59A-2(c)(5).

Prop. Treas. Reg. §1.59A-2(c)(4).

Endnotes

11 Mayer Brown | We Got the BEAT: The IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax

Regulations

Code §59A(c)(4).

See Treas. Reg. § 1.475(a)-1(b), (c) (interest on a debt

instrument subject to mark-to-market accounting is taken

into account before the mark-to-market adjustment).

Treas. Reg. § 1.59A-2(e)(vi).

Treas. Reg. § 1.59A-3(b)(1). Inverted corporations are

subject to a fourth possible type of base erosion payment

for any amount paid to a foreign affiliate which reduces

the corporation’s gross receipts.

Treas. Reg. § 1.59A-3(b)(2)(viii).

Treas. Reg. § 1.59A-3(b)(2)(i).

See Del Commercial Properties, Inc. v. Comm’r, 251 F.3d

210 (2001); Aiken Industries, Inc. v. Comm’r, 56 T.C. 925

(1971); Northern Indiana Public Service Co. v. Comm’r, 115

F.3d 506 (1997); SDI Netherlands B.V. v. Comm’r, 107 T.C.

161 (1996); Anthony Teong-Chan Gaw, T.C. Memo 1995-

531; see also Indianapolis Power & Light Co., 493 U.S. 203

(1990); Illinois Power Co. v. Comm’r, 792 F.2d 683 (7th Cir.

1981).

Treas. Reg. §1.59A-3(b)(2)(ix).

Treas. Reg. §1.59A-3(b)(3)(i)(C).

Treas. Reg. §1.59A-2(e)(3)(ii)(D).

Treas. Reg. § 1.59A-3(b)(3)(ix).

Prop. Treas. Reg. § 1.59A-3(c)(6).

Prop. Treas. Reg. § 1.59A-3(c)(6)(ii)(A)(1).

Prop. Treas. Reg. § 1.59A-3(c)(6)(iii).

Prop. Treas. Reg. § 1.59A-3(c)(6)(ii)(C).

See Treas. Reg. § 1.863-3(h).

Treas. Reg. § 1.59A-3(b)(2)(iii).

Treas. Reg. § 1.446-3(d).

Treas. Reg. §1.59A-3(b)(3)(viii)(A)

Treas. Reg. §1.59A-3(b)(3)(viii)(B)

Treas. Reg. §1.59A-9(b)(4).

Treas. Reg. § 1.882-5(b)-(d), (e).

Under the 2018 Proposed Regulations, the base erosion

payments of taxpayers using the AUSBL method equal the

sum of three items. First, the US branch determines its

interest on qualified nonrecourse indebtedness and

integrated financial products that is attributable to US

assets (directly allocable liabilities) to the extent owed to

foreign related parties. Second, interest paid or accrued

on US-booked liabilities that are owed to foreign related

parties is determined. Third, excess interest is considered

to be paid to foreign related parties in the same ratio that

worldwide liabilities of the whole corporation are due to

foreign related parties.

In the case of a taxpayer using the SCP method, the 2018

Proposed Regulations provided that the base erosion

payments equal the sum of two items. First, like in the

AUSBL method, the US branch determines its interest on

qualified nonrecourse indebtedness and integrated

financial products that is attributable to US assets (directly

allocable liabilities) to the extent owed to foreign related

parties. Second, the interest expense attributable to the

US-connected liabilities in each currency pool is

considered to be paid to foreign related parties in the

same ratio that worldwide liabilities of the whole

corporation in that same currency are due to foreign

related parties.

See February 15, 2019, comment letter submitted by Mayer

Brown, available at Tax Notes Doc 2019-9362.

Treas. Reg. §1.59A-3(b)(4)(i). It should be noted that the

ratio in step (3) is now determined by reference to a

worldwide ratio of interest expense, rather than a

worldwide ratio of liabilities as in the 2018 Proposed

Regulations.

Treas. Reg. §1.59A-3(b)(4)(i)(D).

In the case of expenses other than interest attributable to

a US permanent establishment under a tax treaty, the Final

Regulations provide that internal dealings (i.e., transactions

between the permanent establishment and the home

office or other branches of the foreign corporation) can

give rise to base erosion payments. Treas. Reg. §1.59A-

3(b)(4)(v)(B).

Treas. Reg. §1.59A-3(b)(4)(i)(E).

Treas. Reg. §1.59A-3(c)(2)(ii).

Code § 59A(h)(2).

Treas. Reg. § 1.59A-6(b).

Treas. Reg. § 1.59A-6(d)(2)(iii).

Treas. Reg. § 1.59A-6(d)(2)(iii)(B).

Treas. Reg. § 1.59A-6(d)(2)(iii)(C).

Treas. Reg. § 1.59A-3(b)(3)(v).

Treas. Reg. § 1.59A-3(b)(3)(v)(C).

Treas. Reg. § 1.59A-3(b)(3)(v)(E).

Treas. Reg. § 1.59A-2(e)(3)(ii)(E).

Treas. Reg. § 1.59A-4(b)(1); but see GCM 39701.

Treas. Reg. § 1.59A-4(b)(2)(ii).

Id.

Treas. Reg. § 1.59A-7(b) and (c).

Treas. Reg. § 1.59A-7(d)(2).

Treas. Reg. § 1.59A-9.

12 Mayer Brown | We Got the BEAT: The IRS Issues Final and New Proposed Base Erosion and Anti-Abuse Tax

Regulations

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