Defining Base Erosion Payments Under §1.59A-2

The Base Erosion and Anti-Abuse Tax (BEAT) addresses profit shifting by large multinational corporations that reduce their U.S. tax liability through payments to foreign affiliates. Treasury Regulation §1.59A-2 provides the definitions for calculating this tax, identifying which corporations are subject to BEAT and how it is computed. The regulation defines what constitutes a “base erosion payment” and a “base erosion tax benefit,” which are the core concepts for assessing potential BEAT liability.

Defining a Base Erosion Payment

A transaction is identified as a base erosion payment if it meets three conditions. First, an amount is paid or accrued by a taxpayer. Second, the payment is made to a foreign related party. Third, the payment is deductible for the taxable year.

A taxpayer is subject to BEAT if it is a corporation with average annual gross receipts of at least $500 million over the three preceding tax years. A foreign entity is a related party if it owns, directly or indirectly, at least 25% of the total voting power or value of the taxpayer’s stock. Attribution rules are applied to see through various ownership structures to determine indirect ownership.

For instance, if a U.S. corporation pays deductible interest on a loan from its foreign parent company that owns more than 25% of the subsidiary, the interest payment meets the definition of a base erosion payment. The regulations require that the amount of any base erosion payment is determined on a gross basis, without netting against payments received from the foreign related party.

Specific Categories of Base Erosion Payments

The regulations identify several specific types of transactions that are treated as base erosion payments. These categories highlight common arrangements between U.S. corporations and their foreign affiliates that can reduce the U.S. tax base.

Payments for Depreciable or Amortizable Property

One category of base erosion payments involves the acquisition of depreciable or amortizable property from a foreign related party. When a U.S. taxpayer purchases an asset like machinery or intangible property like a patent from a foreign affiliate, the payment creates the potential for future base erosion. The initial purchase payment is the “base erosion payment,” while the “base erosion tax benefit” arises from the depreciation or amortization deductions claimed in subsequent years.

For example, if a U.S. subsidiary buys equipment from its foreign parent for $10 million, that amount is the base erosion payment. If the subsidiary then claims a $1 million depreciation deduction on that equipment in a given year, that deduction becomes a base erosion tax benefit for that year. This rule prevents companies from structuring transactions as asset acquisitions to circumvent the BEAT.

Reinsurance Premiums

The insurance industry has specific rules concerning reinsurance. Premiums or other considerations paid by a domestic insurance company to a foreign related party for reinsurance are defined as base erosion payments. This applies to reinsurance under section 803 for life insurance companies and section 832 for non-life insurance companies.

These payments are treated as base erosion because they directly reduce the U.S. insurance company’s taxable income. For instance, if a U.S. insurer pays a premium to its foreign parent to reinsure a block of policies, that premium is a base erosion payment.

Payments Reducing Gross Income

The regulations also address certain payments that reduce a taxpayer’s gross income instead of being classified as deductions. This rule targets payments made to a “surrogate foreign corporation” that is a related party. A surrogate foreign corporation is a foreign entity created through a corporate inversion, where a U.S. company reincorporates overseas.

If a U.S. taxpayer makes a payment to such an entity that reduces its gross receipts, such as part of its cost of goods sold (COGS), that payment can be treated as a base erosion payment. This provision is an anti-abuse measure designed to capture payments that would otherwise escape the BEAT framework. This rule only applies if the foreign corporation became a surrogate foreign corporation after November 9, 2017.

Key Exclusions from Base Erosion Payments

Treasury Regulation §1.59A-3 provides several exclusions from the definition of a base erosion payment. These exceptions recognize that certain payments to foreign related parties, even if deductible, do not represent the type of profit-shifting activity the BEAT was designed to prevent. Qualifying for an exception can remove a payment from the calculation entirely.

The Services Cost Method (SCM) Exception

An exclusion exists for payments for services eligible for the services cost method (SCM). This allows a U.S. taxpayer to pay a foreign affiliate for certain low-margin or back-office services without the payment being treated as a base erosion payment. These services often include centralized administrative, clerical, or support functions.

To qualify, the payment must be for the total cost of the services with no markup. If there is a markup, only the portion of the payment equal to the actual cost of the service is excluded; the markup itself is considered a base erosion payment. For example, if a U.S. subsidiary pays its foreign parent $1 million for HR support, and the parent’s actual cost was $1 million, the entire payment can be excluded.

The BEAT’s SCM exception does not include the “business judgment rule” found in transfer pricing regulations. This means a service can qualify for the exception even if it contributes to the fundamental risks of the business. However, the service must not be explicitly ineligible for the SCM, such as manufacturing or research and development.

The Qualified Derivative Payment (QDP) Exception

Another exclusion applies to “qualified derivative payments” (QDPs). A QDP is a payment made pursuant to a derivative contract, provided the taxpayer recognizes gain or loss on the derivative on a mark-to-market basis for tax purposes. This means the derivative is treated as if it were sold for its fair market value on the last business day of the taxable year.

To benefit from the QDP exception, the taxpayer must satisfy specific reporting requirements, including reporting the aggregate amount of QDPs for the year. If a taxpayer fails to meet these obligations, the payments will not qualify for the exception. The IRS has extended a transition period for these reporting rules for taxable years beginning before January 1, 2027, allowing taxpayers to satisfy the requirement by reporting the aggregate QDP amount in good faith.

Total Loss-Absorbing Capacity (TLAC) Securities

A specific exclusion exists for interest and other payments related to total loss-absorbing capacity (TLAC) securities, which is targeted at global systemically important banking organizations (GSIBs). The regulations expand this exception to include securities issued under comparable foreign laws, as long as they are treated as debt for U.S. tax purposes. This prevents payments on these regulatory-required instruments from being treated as base erosion payments.

Other Exclusions

The regulations provide for other exclusions. A loss on a Section 988 foreign currency transaction with a foreign related party is excluded from the definition of a base erosion payment. However, while these losses are excluded from the numerator of the base erosion percentage calculation, they are also excluded from the denominator, which can increase a taxpayer’s base erosion percentage. In contrast, Section 988 losses from transactions with unrelated parties are included in the denominator. Additionally, amounts transferred to a foreign related party in certain corporate non-recognition transactions are generally excluded.

Determining the Base Erosion Tax Benefit

Once a payment is identified as a base erosion payment, the next step is to determine the corresponding “base erosion tax benefit.” This is the amount of the deduction or reduction in gross income that is subject to the BEAT calculation.

For most base erosion payments, the tax benefit is the amount of the deduction allowed for that payment in the taxable year. In the case of payments for depreciable property, the tax benefit is the depreciation or amortization deduction allowed for that property in the given year, not the full purchase price.

These base erosion tax benefits are used to calculate the taxpayer’s “modified taxable income.” This is calculated by taking the taxpayer’s regular taxable income and adding back all of its base erosion tax benefits for the year. The BEAT liability is then determined by comparing the taxpayer’s regular tax liability to a percentage of this modified taxable income. For tax years through 2025, this rate is 10% and increases to 12.5% for tax years beginning after 2025.

An exception exists for payments on which U.S. withholding tax has been paid. The base erosion tax benefit associated with such a payment is not taken into account for the BEAT calculation, though this amount may be reduced depending on the withholding tax rate paid.

Anti-Abuse Provisions and Special Rules

The BEAT regulations include a general anti-abuse rule to prevent taxpayers from structuring transactions to avoid the tax under Section 59A. This gives the IRS the authority to disregard any transaction if a principal purpose was to avoid its application. For example, if a taxpayer uses an intermediary to make a payment to a foreign related party to conceal the nature of the transaction, the rule could be invoked to treat the payment as if it were made directly.

This rule addresses arrangements that may technically comply with the letter of the law but violate its spirit. Another example is a “basis step-up” transaction, where a taxpayer increases the depreciable basis of an asset through a series of transactions with a principal purpose of avoiding BEAT on future depreciation deductions.

Rules for Specific Entities

The BEAT regulations provide special rules for how the tax applies to partnerships and consolidated groups. For partnerships, the regulations adopt an “aggregate” approach, meaning the partnership is treated as a collection of its partners. A payment made by a partnership to a foreign related party of a partner is treated as if it were made directly by that partner, preventing the use of partnerships to indirectly make base erosion payments.

For consolidated groups that file a single federal income tax return, the entire group is treated as a single taxpayer for the BEAT calculation. Transactions between members of the same consolidated group are disregarded. The gross receipts and base erosion percentage tests are applied at the group level, and the BEAT liability is calculated on a consolidated basis.