The Tax Cuts and Jobs Act (TCJA) of 2017 created a new “base erosion and anti-abuse tax” (BEAT) that applies to certain payments made to foreign-related parties by C corporations with annual gross receipts exceeding $500 million. The law allows that payments related to some intercompany services may be excluded from the BEAT calculation — if they meet certain requirements.
What’s transfer pricing got to do with it?
The idea behind the BEAT exclusion was to exempt multinationals from U.S. tax on amounts that they pay to foreign affiliates for the performance of certain low-value intercompany services. The TCJA relied on existing transfer pricing rules, stating that payments for certain specified services like payroll and administrative support will qualify for the exclusion if they’re determined using the “services cost method” (SCM). The rules also permit exclusion of payments for “low-margin” services for which independent companies would charge a markup on cost, determined by a search for comparable companies, equal to or less than 7 percent.
The rules also specify a list of services which by definition cannot be considered low-value and which therefore cannot be excluded from BEAT under the SCM. Each of these considerations constitutes a separate “test” in applying the SCM; all steps and results should be documented in detail in a transfer pricing analysis to establish the case for the BEAT exclusion.Many intercompany payments going out of the United States to a foreign affiliate or parent will be scrutinized to determine if the BEAT should be applied.
Higher stakes under BEAT
Before TCJA, the SCM analysis was used as part of a more comprehensive study to determine if a U.S. affiliate was charging an “arm’s-length” amount for the provision of services to a related foreign party for the purposes of applying transfer pricing rules. The calculation typically applied to the flow of payments for services into the United States.
Under the BEAT, the results of the SCM analysis will now have a direct impact on the company’s U.S. tax obligation. Many intercompany payments going out of the United States to a foreign affiliate or parent will now be scrutinized to determine if the BEAT should be applied, and qualifying service costs will reduce the amount of the payment subject to the new tax.
Time to prepare
The BEAT is effective for tax years starting after Dec. 31, 2017. While it won’t actually be calculated on returns until early 2019, there are several reasons to begin examining intercompany service payments now:
- For many businesses, the transfer pricing methodology has focused on incoming payments for services provided by the U.S entity. The BEAT will require an analysis of outgoing service payments that may not have been included in previous studies.
- Until now, the tax benefit from calculating “low-value” services may not have been sufficient to warrant the cost of tracking them. Now that they have a potential to more directly affect the U.S. tax obligation, the benefit may justify the cost.
- Intercompany service agreements, as well as service fee calculations, may be redefined to provide more detail on exactly what services are covered, and what the costs for individual services are, to make sure that charges to be excluded can be identified and distinguished from charges for nonexcludable services.
Many questions still need to be answered about the BEAT exclusion for intercompany service payments. For instance, it’s unclear at this point whether the whole charge of the covered service can be excluded or only the base cost — or only the markup. The important thing to understand is that outbound intercompany service payments have become much more important for multinationals; and the sooner a business acts to properly calculate and track those costs, the better positioned it will be to file an accurate tax return.
Stay tuned for additional information as the IRS releases guidance on the BEAT tax, and as always, feel free to reach out to us with questions.