Proposed Regulations Clarify the BEAT and FATCA
Saren Goldner | January 16, 2019
On December 13, 2018, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued two sets of proposed regulations of importance to insurance companies. One set was the long-awaited regulations under section 59A of the Internal Revenue Code of 1986, as amended (Code), commonly referred to as the base erosion and anti-abuse tax (BEAT). The other set of proposed regulations amended the Foreign Account Tax Compliance Act (FATCA) regulations that apply to sections 1441–1446 of the Code.
Notably, with respect to insurance companies, the proposed regulations provide as follows.
Payments made to a non-US corporation are not treated as BEAT payments to the extent they are included in the calculation of the corporation's effectively connected income or income allocable to a permanent establishment.
General federal tax principles apply in determining whether a payment is a deductible payment treated as a base erosion payment or a reduction to gross income not treated as a base erosion payment.
A de minimis exception to the decreased base erosion percentage is applicable to registered securities dealers.
For FATCA purposes, premiums paid for non–cash value insurance policies will no longer be characterized as "withholdable payments."
The Proposed BEAT Regulations
The purpose of the BEAT is to function as a minimum tax1 that applies to US taxpayers in an aggregate group that have annual average gross receipts over a 3-year period of at least $500 million and have a base erosion percentage of at least 3 percent (or 2 percent in the case of banks and registered securities dealers). If an aggregate group meets the above thresholds, each US taxpayer (determined on a consolidated group basis) in the aggregate group is subject to the BEAT.
Whether BEAT is due is determined by comparing the US taxpayer's "modified taxable income" (MTI) multiplied by the applicable BEAT rate for the taxable year to the taxpayer's regular tax liability for the taxable year without taking into account certain credits. If a taxpayer's regular tax liability exceeds its MTI multiplied by the applicable BEAT rate, no tax is imposed under section 59A.
The discussion below highlights some of the key takeaways from the proposed BEAT regulations.
Aggregate Group versus Taxpayer
The proposed BEAT regulations make clear that, although the application of the gross receipts and base erosion percentage tests is on an aggregate basis, including all corporations within a section 52(a) controlled group (using 50 percent instead of 80 percent), the determination of MTI and the calculation of the BEAT amount is on a single taxpayer basis. For this purpose, corporations included in a consolidated group are treated as a single taxpayer. Thus, each US branch will be treated as a single taxpayer as will, in general, any unseasoned life insurance company in a life non-life group.
The proposed BEAT regulations also clarify that payments between members of the aggregate group, including payments treated as effectively connected income of a non-US member of the aggregate group, are not taken into account in applying the gross receipts test or determining the base erosion percentage.
Base Erosion Payments
The proposed BEAT regulations clarify that the exception to the treatment of a payment as a base erosion payment for services that are eligible for the services cost method under Treas. Reg. § 1.482-9(b) applies to a services payment even if the payment includes a markup. The markup component (but not the rest of the service payment) is treated as a base erosion payment. The taxpayer is required to maintain appropriate books and records from which the markup component can be determined.
Other clarifications made in the proposed BEAT regulations regarding the determination of whether an amount is treated as a base erosion payment include the following.
Payments in cash or any form of noncash consideration may be treated as base erosion payments.
Exchange loss from a section 988 transaction is not treated as a base erosion payment.
Only amounts accrued in tax years beginning after December 31, 2017, are treated as base erosion payments.
De Minimis Exception for Registered Securities Dealers
The proposed regulations provide that the aggregate group is not subject to the lower base erosion percentage trigger of 2 percent, instead of 3 percent, if the gross receipts attributable to the registered securities dealer are less than 2 percent of the aggregate group's gross revenue. The exception also applies in the case of de minimis bank gross revenue. Notably, if the 3 percent base erosion percentage trigger is met (as well as the gross revenue trigger), there is no exception for the application of the higher BEAT rate applicable to a single taxpayer that includes a registered securities dealer (or bank).
Special Rules Relating to Insurance Companies
The proposed BEAT regulations provide limited guidance for insurance companies and request further comments, most notably as follows.
Amounts paid under a reinsurance contract between an applicable taxpayer and a related foreign party are not netted but are included on a gross basis regardless of whether or not the reinsurance contract is settled on a net basis. However, the proposed BEAT regulations appear to indicate that return premiums reduce premium and are therefore not subject to the BEAT.
If a domestic reinsurance company makes claim payments to a foreign related ceding company pursuant to a reinsurance contract, such amounts may be subject to the BEAT. However, payments that are treated as reductions to gross income under section 832(b)(3)—which might be the case for a non-life insurance company—may not be subject to the BEAT. The preamble notes the potential difference between the treatment of claim payments by life and by non-life domestic reinsurance companies and has requested comments on this issue.
Payments made or accrued to a foreign insurance company that has made an election to be treated as a domestic company under section 953(d), as well as payments that are made to a US branch and are treated as effectively connected income, are not subject to the BEAT. A payment made by a section 953(d) company, or a US branch, to a foreign related corporation could potentially be subject to the BEAT.
Insurance companies must calculate their gross receipts and base erosion percentage disregarding payments between members of their aggregate group, including payments treated as effectively connected income of a foreign member of the aggregate group.
The Proposed FATCA Regulations
The proposed FATCA regulations provide that premiums for insurance contracts that do not have a cash value are excluded nonfinancial payments, and thus are not subject to withholding. The preamble to the proposed FATCA regulations indicates that this is a result of the recent law changes to the insurance exception to the passive foreign investment company (PFIC) rules.
The preamble to the proposed FATCA regulations indicates that, although FATCA strengthened the IRS's enforcement efforts with respect to the use of the insurance exception to the PFIC rules, the enhanced enforcement under FATCA is no longer necessary. The prior law insurance exception provided that non-US corporations predominantly engaged in the active conduct of an insurance business that would be characterized as insurance companies for US federal tax purposes would not be characterized as PFICs, and thus their shareholders would not be subject to the PFIC reporting and antideferral rules. The Tax Cuts and Jobs Act instituted a more limited insurance exception under the PFIC rules by requiring non-US insurance companies to have a specified percentage of insurance liabilities to total assets in order to meet the exception.
The preamble indicates that, as a result of this change, it is anticipated that insurance companies that do not meet the revised insurance exception will amend their business models or their shareholders will be required to comply with the PFIC reporting requirements, eliminating the need to withhold premiums for non–cash value policies.
In addition, the proposed FATCA regulations provide clarification of the meaning of an "investment entity" for purposes of the FATCA rules. Under current Treas. Reg. § 1.1471-5(e)(4)(i)(B), an entity is an investment entity (and therefore a financial institution) if the entity's gross income is primarily attributable to investing, reinvesting, or trading in financial assets, and the entity is "managed by" another entity that is a depository institution, custodial institution, insurance company, or an investment entity described in Treas. Reg. § 1.1471-5(e)(4)(i)(A).
The proposed FATCA regulations provide that an entity is not "managed by" another entity merely because it makes investments in a mutual fund, exchange-traded fund, or collective investment entity that is widely held and is subject to investor-protection regulations. This change correlates to the interpretation of "managed by" in similar guidance published by the Organisation for Economic Co-operation and Development. The preamble to the Proposed FATCA Regulations indicates that "managed by" refers to professional management with discretionary authority.
- The BEAT rate is 5 percent for tax years beginning in 2018, 10 percent for tax years beginning after 2018 and before 2025, and 12.5 percent for tax years beginning after 2025 (or 6 percent, 11 percent, and 13.5 percent, respectively, in the case of banks and registered securities dealers).
Saren Goldner | January 16, 2019