Our Voices

Beware of the BEAT: Taxing Certain Deductible Payments Made to Related Foreign Persons

By Farzaneh Savoji

The Tax Cuts and Jobs Act (the “Act”) added section 59A to the Code to impose a new “base erosion” minimum tax on large corporations to prevent companies from stripping earnings out of the U.S. through payments to foreign affiliates that are deductible for U.S. tax purposes. This new tax is described as a base erosion and anti-abuse tax, or “BEAT.”

The tax is structured as an alternative minimum tax that applies when a multinational company reduces its regular U.S. tax liability to less than a specified percentage of its taxable income, after adding back deductible base eroding payments and a percentage of tax losses claimed that were carried from year to year.

The tax applies to deductible payments to foreign affiliates from domestic corporations and on foreign corporations engaged in a U.S. or business (when computing the tax on their effectively connected income).

A base erosion payment is any amount paid or accrued by the taxpayer to a foreign person that is a related party and with respect to which a deduction is allowed. This includes any amount paid or accrued to a related foreign person in connection with the acquisition of depreciable or amortizable property. 

 BEAT is imposed only on a taxpayer that is an applicable taxpayer who: 

  • is a corporation, other than a RIC, a REIT, or an S corporation;
  • with an average annual gross receipts of at least $500 million for the three tax-year period ending with the preceding tax year; and
  • has a base erosion percentage of 3% or higher (2% for securities dealers) for the tax year.

If the taxpayer is an applicable taxpayer then the corporation should conduct computations to determine if there is BEAT exposure.

BEAT rate is 5% for tax years beginning in calendar year 2018, 10% for tax years beginning in 2019 through 2025, and 12.5% for tax years beginning after December 31, 2025.

A corporation’s modified taxable income is determined by adding back to taxable income current year deductions involving payments to related foreign persons.  

Generally, the BEAT’s add-back for deductible amounts paid or accrued to a related foreign person include payments for services, interest, rents and royalties. For purposes of this section, a foreign person is related if it is treated as owning at least 35% of the stock of the taxpayer (by vote or value) or satisfies various other relationship or control tests.

The minimum base erosion tax is intended to apply to companies that significantly reduce their U.S. tax liability with base erosion payments to foreign affiliates. Thus, a taxpayer that reduces its tax liability to an amount that is less than 10% of its modified taxable income has to pay the alternative tax.

Our View

Large corporate taxpayers should identify transactions that may subject them to BEAT as a result of payments to a related party that creates a deductible item. If there is exposure, the taxpayer should conduct computations under multiple scenarios to understand how various margins and net operating losses will impact taxable income. If there is BEAT exposure through payment streams, we recommend analysis on restructuring to reduce amounts added back to regular taxable income when calculating modified taxable income. 

Should you have any questions or desire further insight, feel free to contact one of the members of our Tax Department:

Mayer Nazarian, Chair of the Tax Department
Phone: (310) 400-0110
Email: mnazarian@ckrlaw.com

Eli Akhavan, Chair of the Private Clients and Wealth Preservation Practice Group
Phone: (212) 259-7300
Email: eakhavan@ckrlaw.com

Aman Badyal: (619) 500-4540, abadyal@ckrlaw.com
Elizabeth Larrauri Chamulak: (212) 259-7300, echamulak@ckrlaw.com
Gary Edelstone: (310) 400-0110, gedelstone@ckrlaw.com
Gordon Einstein: (310) 400-0110, geinstein@ckrlaw.com
Jon Hughes: (215) 618-8988, jhughes@ckrlaw.com
Ronniel Levy: (212) 259-7300, rlevy@ckrlaw.com
Elizabeth Nelson: (310) 400-0110, enelson@ckrlaw.com
Farzaneh Savoji: (310) 400-0110, fsavoji@ckrlaw.com
Michael Shaff: (949) 265-2622, mshaff@ckrlaw.com
Zoila Villacorta: (310) 400-0110, zvillacorta@ckrlaw.com

DISCLAIMER: This article is not intended to provide legal advice, and no legal or business decision should be made based on its contents.