by Chris Carroll and Lary LeBlanc
The tax bill H.R. 1, also known as the Tax Cuts and Jobs Act (TCJA), is intended to lower business tax rates and modernize U.S. international tax rules. Not surprisingly, the TCJA is currently generating as many questions as answers for U.S. subsidiaries of foreign-based auto manufacturers. Specifically, the base erosion and anti-abuse tax (BEAT), which is designed to curtail perceived erosion of the U.S. tax base, is currently creating additional uncertainty regarding how multinational companies will address the changing global landscape of intercompany transaction management in conjunction with their value chains.
The BEAT affects multinational corporations that make base erosion payments to their foreign-related parties in excess of 3 percent of adjusted deductions for the current year. In addition, these provisions apply to larger corporations with at least $500 million in average U.S. gross receipts in the prior three years. Base erosion payments are classified as intercompany interest, royalties and service fees (that include a mark-up), but exclude payments related to tangible goods that might be purchased by a U.S. corporation from its foreign-related parties. Essentially, these provisions have similar mechanical characteristics as the corporate alternative minimum tax that was repealed by H.R. 1.
General Transfer Pricing Matters
Under existing U.S. transfer pricing rules, certain low-margin services—including accounting and administrative services—do not require a mark-up. Accordingly, these cost-basis transactions would not be subject to BEAT. However, while no mark-up is required for U.S. tax purposes, the corresponding foreign country tax authority (e.g., Japan) may argue that such services do require a mark-up. As such, the marked-up transaction would be subject to BEAT.
Additionally, if a company’s transfer pricing policy regarding low-margin services is to apply a mark-up, the company could be put into the tough position of having to choose between paying the BEAT in the United States or revising its transfer pricing policy to remove the mark-up and risk a tax authority inquiry and audit in the jurisdiction of the foreign-related party providing the services (and thereby causing the foreign-related party to incur the additional time and cost of responding to the audit along with any tax, penalties and interest that may result from an adverse audit outcome).
Advanced Pricing Agreements and Tax Treaties
Due to the fact that BEAT places cross-border related-party payments in its crosshairs, it may have significant adverse consequences for foreign-based automakers with substantial international transfer pricing arrangements that include their U.S. taxpayers. For example, global groups that have entered into advanced pricing agreements (APAs) with the United States may find that they are now placed into an adverse tax position. Such groups will need to carefully analyze whether or not their particular circumstances would allow them to obtain relief from the potentially burdensome provisions of APAs.
Another question yet to be answered is whether the BEAT violates nondiscrimination provisions of U.S. tax treaties. Article 24, paragraph 4 of the Model Convention basically provides that interest, royalties and other disbursements paid by a U.S. company to a foreign company should not receive deductibility treatment different from similar payments made between two U.S. companies. The BEAT appears to target payments based on the recipient’s residence. However, competent authority may contend that the BEAT was intended to affect the applicable tax rate. Thus, it has no effect on the deductibility of the payments. It is not clear which argument will ultimately succeed.
Royalties
Although not directly related to transfer pricing, a U.S. subsidiary’s classification of royalty payments to a foreign-related party as a component of cost of goods sold (COGS)—versus selling, general and administrative expenses (SG&A)—will be critical to the imposition of the BEAT. Payments related to COGS will not be subject to BEAT, whereas payments related to SG&A will be subjected to BEAT.
Consider Your Options
Inbound automotive companies engaging in licensing, borrowing or obtaining services from a non-U.S. related party are likely to be some of the most affected by the BEAT. Even though there are many issues surrounding these provisions to be resolved, automakers and suppliers will need to re-evaluate their value chains and consider alternative options for cross-border payments in order to reduce exposure.
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