The Implications of the Base Erosion and Anti-Abuse Tax on the Use of the Services Cost Method for Transfer Pricing Documentation
August 30, 2018
By Henric Adey and Michaela Culver
Overview of the BEAT
The Tax Cuts and Jobs Act (“TCJA”) introduced the Base Erosion and Anti-Abuse Tax (the “BEAT”). The BEAT operates as a limited-scope alternative minimum tax, applied by adding back taxable income to certain previously deductible payments. The BEAT applies to corporations with annual gross receipts for a three-taxable-year period of $500 million or more. Companies subject to the BEAT will have a minimum tax calculated on the excess of the U.S. company’s modified taxable income -- that is, the taxable income combined with base erosion payments and net operating losses attributed to such payments. The BEAT rate is 5% for tax years beginning in the calendar year 2018, 10% for tax years beginning in 2019 through 2025, and 12.5% for tax years after December 31, 2025. While long-term international tax planning around the BEAT would be optimal, many practitioners and industry are looking towards the final regulations and further guidance.
Transfer Pricing Implications of the BEAT
The BEAT imposes a tax on intercompany transactions and services in some circumstances. Subjecting some of these expenditures to United States taxation, the BEAT has a specific exemption for certain intercompany services performed and charged with no markup. Section 59A (d)(5) explains the exception: “[the BEAT] shall not apply to any amount paid or accrued by a taxpayer for services if (A) such services are services which meet the requirements for eligibility for use of the services cost method under section 482 (determined without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure); and (B) such amount constitutes the total services cost with no markup component.” This evokes the major question of marked-up services for companies reporting their transfer pricing with the Services Cost Method.
There is a strong argument that intercompany service payments could be bifurcated—that is, exempting the portion of payment before the arm’s length markup and then imposing the BEAT on the markup charged. The alternative interpretation would be that a complete payment must have no markup component in order to qualify for the exemption. This would not allow a bifurcated approach to reporting the costs for purposes of determining the BEAT.
While commentary is split on the approaches, it would be far more complicated to adopt and offer a bifurcated approach. On the other hand, a bifurcated approach offers important tax incentives and benefits to US corporations. In order to implement a bifurcated approach, companies would have to have sufficient documentation and justification for the line between the cost and the markup.
While there are compelling arguments on both approaches, the mechanics of the implementation and complications should also be considered. We are awaiting the tax authorities’ development of clear and concise guidance, in order to support efficient tax planning around the BEAT.