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This historical accounting treatment has created an assumption within many services companies that their payments to related parties for services would qualify as a “reduction” of revenue. These costs have historically been deductible, and, for accounting purposes, some taxpayers have even applied the deduction “above the line” – meaning that they treated the deduction as a “reduction to gross receipts” for financial statement purposes. For services companies, however, the costs inherent in providing the services are costs of services, not COGs. Why does this matter? Effectively, any portion of base erosion payments that can rightfully be considered COGs may be excluded, meaning that the taxpayer is not penalized (i.e., BEAT does not apply) on that portion. It is a deduction to gross income that is used to arrive at a company’s net income for tax purposes. Conversely, a “deduction” is not a reduction to gross receipts. So, what does “reductions to gross receipts” mean? Reduction to gross receipts is a term of art referring to the concept that some costs constitute a reduction in gross receipts when arriving at gross income. While manufacturers and retailers, on the other hand, get the benefit of excluding COGs, and thereby avoid the harsh impact of the BEAT on such imports. Therefore, services firms will likely be required to include their costs of services (paid to related parties outside the U.S.) as payments subject to the BEAT. However, given the current law, it is highly unlikely that costs of services may be treated in a similar manner (i.e. Note our emphasis on the word “reduction.” As we’ll discuss below, costs of goods (“COGs”) are considered reductions to gross revenue and as such are not subject to the BEAT. It all hinges on a rule that allows “reductions to gross receipts” to be excluded from the definition of “base eroding payments.” The rule provides that any amounts that reduce gross receipts are excluded as base eroding payments for purposes of the BEAT. Up to this point, you may be wondering how services companies are being treated differently than those in the manufacturing or retail space.
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Impacts to the Services Industry: Costs of Goods vs. corporation’s aggregate allowable deductions in the current taxable year. base eroding payments) must exceed 3 percent of the U.S. corporation’s deductible payments made to related parties (i.e. corporation must have average annual gross receipts in excess of $500 million over the past 3 years. If the taxpayer does not meet the criteria of either test, the BEAT does not apply. corporation must pass two thresholds before the BEAT is applicable. If the resulting “modified tax liability” is higher than the taxpayer’s actual tax liability, the difference is the BEAT and must be paid in addition to the “regular” U.S. This new modified taxable income amount is then hit with a 5 percent rate (or 10 percent for taxable years beginning after December 31, 2018) to determine the modified tax liability. In determining the minimum tax, base eroding payments are added back to the company’s taxable income. certain deductible payments to related foreign parties). multinationals that make base eroding payments (i.e. The BEAT is a new minimum tax targeted at U.S. In this edition of Tax Advisor Weekly, we explain the BEAT, why companies in the services industry are at a distinct disadvantage under the BEAT, and a method that may be used overcome that disadvantage. corporations, companies that provide services to their customers, when compared to companies in the manufacturing or retail space, find themselves at a distinct disadvantage under the BEAT.
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Even though the BEAT applies broadly to large U.S. Structured Finance & Capital Equipment ValuationĬost of Services are Out, Services Cost Method is Inįor companies in the services industry, the Base Erosion and Anti-Abuse Tax (“BEAT”) may feel like a dominating force that’s impossible to overcome. Portfolio Company Performance Improvement Merger, Acquisition & Divestiture Services