What Qualifies as a Base Erosion Payment?
Gain insight into how U.S. tax law distinguishes between deductible cross-border payments that can trigger the Base Erosion and Anti-Abuse Tax.
The Tax Cuts and Jobs Act of 2017 introduced the Base Erosion and Anti-Abuse Tax (BEAT), a provision aimed at large multinational corporations that reduce their U.S. tax obligations by making deductible payments to foreign-affiliated entities. The BEAT regime functions as a type of minimum tax, ensuring that these corporations contribute a baseline amount of tax in the United States.
Identifying an Applicable Taxpayer
A corporation is subject to the Base Erosion and Anti-Abuse Tax if it is an “applicable taxpayer,” a status determined by two criteria under Internal Revenue Code (IRC) Section 59A. The first is a gross receipts test, met if the corporation’s average annual gross receipts for the three preceding tax years are at least $500 million.
The second criterion is the base erosion percentage test. For most corporations, this test is met if their base erosion percentage is 3% or higher for the taxable year. This percentage is calculated by dividing the total base erosion tax benefits by the aggregate of most allowable deductions. For certain financial institutions, like banks and registered securities dealers, a lower threshold of 2% applies.
Defining a Base Erosion Payment
A base erosion payment is any amount paid or accrued by a taxpayer to a foreign related party for which a deduction is allowable. This can include payments for interest, royalties, and various services. A “foreign related party” generally includes any 25% foreign shareholder or other entities related to the taxpayer under established attribution rules.
Deductions for depreciation or amortization can also be treated as base erosion payments. This occurs if the underlying property was acquired from a foreign related party, preventing companies from circumventing the rules by acquiring assets instead of making direct payments.
An exclusion from this definition is any amount that constitutes the Cost of Goods Sold (COGS). Payments that are properly capitalized into inventory costs are not considered base erosion payments.
Exceptions to Base Erosion Payments
A payment to a foreign related party may not be a base erosion payment if it falls under an exception. One exception is for services eligible for the Services Cost Method (SCM) under IRC Section 482. This allows payments for specific back-office services to be excluded, but only up to the actual cost of providing the service. Any markup paid above the cost is still considered a base erosion payment.
To qualify for the SCM exception, the service must not be a core part of the business’s value creation, such as manufacturing or research and development. The taxpayer must also maintain adequate books and records to substantiate the costs of the services provided.
Another exception applies to qualified derivative payments (QDPs). This rule excludes certain payments made on a derivative contract with a foreign related party, provided specific reporting and mark-to-market accounting requirements are met.
Calculating the Base Erosion Minimum Tax Amount
The BEAT calculation determines if a corporation owes an additional minimum tax. A taxpayer’s regular taxable income is adjusted to arrive at “modified taxable income” (MTI) by adding back deductions for base erosion payments and a portion of any net operating loss (NOL) deductions.
The MTI is multiplied by the applicable BEAT tax rate to determine the tentative BEAT liability. The rate is 10% for tax years through 2025 and increases to 12.5% for tax years beginning after 2025.
A corporation’s final BEAT liability is the amount by which the tentative BEAT exceeds its regular income tax liability. Certain tax credits cannot be used to offset the BEAT. If the tentative BEAT is higher than the regular tax liability, the difference is the BEAT owed.
Reporting and Filing Requirements
Applicable taxpayers must fulfill specific reporting obligations related to the BEAT, even if no tax is ultimately due. The primary tool for this is IRS Form 8991, “Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts.” This form is used to calculate and report the base erosion minimum tax amount.
Schedule A of Form 8991 is used to determine the amount of base erosion payments and the corresponding tax benefits. The form also requires the taxpayer to calculate its base erosion percentage to confirm its status as an applicable taxpayer. The completed Form 8991 must be attached to the corporation’s annual income tax return.