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How the BEAT Could Affect Renewable Energy Investing

Published by Forrest D. Milder on Thursday, May 3, 2018

Journal cover May 2018   Download PDF

H.R. 1 (the 2017 tax legislation) made only a few changes to the Internal Revenue Code (IRC) that could directly affect renewable energy, but one was the addition of a new minimum tax, the Base Erosion Anti-Abuse Tax, or BEAT. 

The BEAT only applies to certain large, international taxpayers, but some of these also invest in tax credit projects. This month, we’ll consider how the BEAT might affect investment in renewables.

Overview 

Some American taxpayers lower their U.S. tax liability by incurring deductible expenditures to their affiliates in low-tax jurisdictions. The BEAT discourages this practice by requiring the American corporation to reverse those deductions (and add back gross income directed toward foreign affiliates) and then applies a minimum tax rate to this recomputed income.

Unfortunately, the BEAT also imposes adverse treatment on some tax credits, including (but not limited to) the renewable energy production tax credit (PTC) and investment tax credit (ITC; together, RETC), and this can affect their value.

In the interest of keeping this discussion manageable, what follows is a simplified overview of how the BEAT is computed and why it can be an issue for tax credit transactions.

Some Terminology

First, you need to know a few terms added by H.R. 1.

Applicable Taxpayers. The BEAT only applies to corporations which (i) are not regulated investment companies, real estate investment trusts (REITS) or S corporations, and (ii) have average annual gross receipts of at least $500 million for the most-recent three-year period and a “base erosion percentage” (defined below) of 3 percent (2 percent for certain banks and securities dealers) or more for the taxable year.

Base Erosion Tax Benefits. These are deductible fees incurred to, and/or gross income directed to, foreign affiliates of an applicable taxpayer. The foreign affiliates taken into account are those that own at least 25 percent of the stock of the applicable taxpayer (by vote or value) or which meet certain direct, indirect and constructive ownership tests.

Base Erosion Percentage. This number is computed by dividing the corporation’s base erosion tax benefits by most of the corporation’s other allowable deductions.

Some Math

The new IRC provisions provide many mathematical computations to determine whether a corporation has BEAT liability. I’ve added some of my own terminology to make the mathematics easier to follow:

Normal tax liability. An applicable taxpayer computes its normal tax liability using the conventional tax system, including all of the effect of its tax credits, including the ITC or PTC.

Adjusted tax liability. For years that begin through 2025, the corporation then adds back some or all of three tax credits: 100 percent of the corporation’s research and development credits, and 80 percent of its RETCs and low-income housing tax credits (LIHTCs). Importantly, these adjustments are no longer made starting with tax years beginning after 2025. Starting in that year, the corporation’s normal tax liability and its adjusted tax liability are the same.

Preliminary BEAT. Next, the applicable taxpayer computes its normal taxable income, but it does not include the deductions associated with otherwise-deductible payments to related foreign affiliates, and it adds back income it directed to these affiliates. It multiplies this amount by 5 percent for 2018, 10 percent for 2019 through 2024 and 12.5 percent in 2025 and later years. For certain banks and securities dealers, these percentages are increased to 6, 11 and 13.5 percent, respectively.

The BEAT. Next, the corporation compares the preliminary BEAT to its adjusted tax liability. If the preliminary BEAT is larger, then the difference is the BEAT. If the adjusted tax liability is equal or larger that the preliminary BEAT, then the corporation’s BEAT is zero.

Total tax liability. Finally, the corporation adds its normal tax liability to its BEAT to determine its total tax liability.

Illustrations 

To help understand how the BEAT can affect RETC investments, a few illustrations may be useful.

Computation in 2019. Assume an applicable taxpayer is subject to the 21 percent regular tax rate and the 10 percent BEAT rate that applies in 2019. Suppose it has $20,000 of income, less $10,000 of deductions not attributable to base erosion, as well as a deductible payment to a foreign affiliate of $5,500 that is considered a base erosion tax benefit, and a RETC of $100. On these facts, this first corporation’s normal tax liability is $20,000 of income less $15,500 of all deductions (including the ones attributable to its foreign affiliate), multiplied by the 21 percent corporate tax rate, or $945 of tax, further reduced by its $100 of RETC to $845. Next, its adjusted tax liability is its normal tax liability of $845, plus 80 percent of its RETC, or $80, which equals $925.

This same corporation’s preliminary BEAT is $20,000 of income less $10,000 of non-base-erosion deductions multiplied by 10 percent, or $1,000. Since the corporation’s adjusted tax liability of $925 is less than the corporation’s preliminary BEAT of $1,000, the corporation’s BEAT is the difference, or $75. Thus, this corporation’s total tax liability is $845 plus the BEAT of $75, or a total of $920. Because this corporation would have otherwise owed the preliminary BEAT of $1,000, its $100 RETC saved it $80 of tax. Thus, the RETC was worth somewhat less than the applicable taxpayer had originally anticipated.

Slightly different computation in 2019. Assume a second applicable taxpayer in 2019, with $40,000 of income, $20,000 of deductions not attributable to base erosion, a base erosion tax benefit of $9,500 and a RETC of $500. Its normal tax liability is $40,000 of income less $29,500 of all deductions, or $10,500. At the 21 percent corporate tax rate this is $2,205 of tax, further reduced by its $500 of RETC to $1,705. This corporation’s adjusted tax liability is its normal tax liability of $1,705, plus 80 percent of its RETC, or $400, a total of $2,105. 

This same corporation’s preliminary BEAT is $40,000 of income less $20,000 of non-base-erosion deductions multiplied by 10 percent, or $2,000. Because its adjusted tax liability of $2,105 is more than the corporation’s preliminary BEAT ($2,000), this second corporation doesn’t owe any BEAT. As a result, the $500 RETC saved this second corporation a full $500 of tax.

Assume the same facts as our first example, except that it is 2026. Fast forward a few years, when we no longer do the 80 percent adjustment for the RETC. Our first applicable taxpayer’s normal tax liability would be the same: $945 less $100 of RETC, or $845. However, the corporation’s adjusted tax liability is now the same, because the RETC is no longer added back to the computation. The preliminary BEAT would be $20,000 less $10,000 of deductions not attributable to base erosion, times the 12.5 percent BEAT rate for 2026, or $1,250. This number is larger than the corporation’s adjusted tax liability of $845. As a result, its BEAT is $1,250 less $845, or $405, and the corporation’s total tax liability is the sum of its adjusted tax liability of $845 and the BEAT of $405, or $1,250. The $100 of RETC didn’t reduce the corporation’s tax bill.

Observations

There are some important takeaways associated with the BEAT.

Retroactivity. The BEAT can be retroactive. It can apply to tax credits generated by previously closed transactions for which the tax credit accrues after the BEAT became law. For example, if a corporation invested in a PTC transaction in 2015, with a 10-year credit period running from 2017 through 2026, then starting in 2018, the computation of the BEAT might make the PTC less valuable, or even worthless after 2025, even though the investment was made before the BEAT even existed.

Other credits. RETCs are not the only credits caught in the BEAT’s web. The LIHTC gets the same 80 percent treatment as the RETC and for the same number of years. And the historic rehabilitation tax credit and the new markets tax credit are not usable against the BEAT at all, even in 2018 and continuing thereafter. As a result, for the next few years, the RETC has a bit of an edge on some credits when it comes to applicable taxpayers as potential investors. Nonetheless, the 80 percent adjustment may make the RETC worth something less than it used to be.

No rules of thumb. This is an abbreviated overview of the BEAT; the actual computations are sufficiently complex that many corporations have their accounting team working overtime to analyze its impact. It is hard to calculate how the BEAT will affect any particular applicable taxpayer, because the computation depends on whether the BEAT is larger (and by how much) than the corporation’s normal tax liability, and this can vary greatly. For example, in my first 2019 example above, you might not have guessed that the $100 of RETC would reduce the corporation’s tax liability by $75.

The rules only apply to applicable taxpayers. Don’t forget the floors and minimums for determining whether a corporation is an applicable taxpayer. Corporations with less than $500 million of average annual revenue, or a base erosion percentage that is less than 3 percent (2 percent for certain banks and securities dealers) won’t be subject to the BEAT, and can stop thinking about it. 

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