The base erosion and anti-abuse tax (BEAT) has emerged as a significant consideration for corporations navigating the complexities of international transactions. This minimum tax, which started at 5% in 2018 and is set to rise to 12.5% after 2025, targets applicable taxpayers making certain base erosion payments to foreign related parties. This tax is an addition to a corporation’s regular income tax liability.
Corporations averaging at least $500 million in U.S. gross receipts over the past three years fall under the BEAT’s purview. This threshold includes receipts from related corporations, encompassing parent-subsidiary and brother-sister controlled groups. However, there is a safe harbor for corporations with a base erosion percentage below 3% (2% for banks and financial institutions).
Understanding Base Erosion Payments
Base erosion payments are broadly defined, including interest, royalties, management fees, and other certain tax-deductible amounts paid or accrued to related foreign persons. According to the lease definition, payments properly reflected in the cost of goods sold on the U.S. income tax return do not constitute base erosion payments. The regulations provide several exceptions to this broad definition, one of which pertains to Qualified Derivative Payments (QDPs).
Qualified Derivative Payments
The section 59A regulations define a QDP as any payment made by a taxpayer to a foreign related party pursuant to a derivative, where the taxpayer:
- Recognizes gain or loss as if the derivative were sold for its fair market value (FMV) on the last business day of the taxable year (and any additional times as required by the Internal Revenue Code or the taxpayer’s method of accounting);
- Treats any gain or loss so recognized as ordinary; and
- Treats the character of all items of income, deduction, gain, or loss with respect to a payment pursuant to the derivative as ordinary.
However, for a payment to be considered a QDP, specific reporting requirements must be met. Taxpayers must report the aggregate amount of QDPs for the taxable year on Form 8991 and make a representation that all payments satisfy the requirements of Reg. section 1.59A-6(b)(2).
Reporting Requirements and Compliance
If a taxpayer fails to meet these reporting requirements, the payments will not qualify as QDPs and will be considered base erosion payments unless another exception applies. This misclassification can subject the taxpayer to BEAT, increasing their tax liability. Additionally, the IRS may impose penalties for underpayment of taxes due to inaccurate reporting, which can include a percentage of the underpayment, interest on the unpaid amount, and in some cases, criminal charges if inaccuracies are found to be fraudulent.
During the transition period before the applicability of Reg. section 1.6038A-2(b)(7)(ix), taxpayers are treated as satisfying the QDP reporting requirements if they report the aggregate amount of QDPs on Form 8991, Schedule A, in good faith.
The provisions described are subject to change in any finally enacted regulation package. Taxpayers should consult their advisors to better understand how Notice 2024-43 may affect their tax obligations.
