The Impact of BEAT on U.S.-Foreign Affiliated Reinsurance
By Sandra Lopez P.
Taxing Times, December 2020
Executive Summary
Enacted pursuant to the 2017 Tax Cuts and Jobs Act (TCJA)[1], the base erosion and anti-abuse tax (BEAT) is one of the most dramatic changes to the U.S. international tax landscape in recent years. The BEAT is essentially a minimum tax which applies to certain large U.S. and foreign corporations with U.S. operations with average annual gross receipts of at least $500 million and a base erosion percentage of 3 percent or higher (with some exceptions). The BEAT applies in addition to other taxes imposed under the Internal Revenue Code (the Code)[2], including regular corporate income taxes and federal excise taxes (FET) on premiums paid to foreign insurers and reinsurers with respect to risks located in the United States. The BEAT applies to “base erosion payments” i.e., certain deductible amounts paid or accrued by an applicable taxpayer (U.S.) to a related foreign party. The definition of the term “base erosion payments” raises unique issues for insurance and reinsurance tax purposes. This article discusses BEAT generally and explores key insurance-specific issues that commonly arise in the context of foreign affiliated (re)insurance transactions.
Key Takeaways Specific to the Insurance Industry:
Regulations adopted subsequently to enactment of the BEAT have provided clarity with regard to aspects of the new tax that are particularly impactful for the insurance industry. Key takeaways in that regard may be summarized as follows:
- Claims payments made by a U.S. reinsurer to an affiliated foreign insurer may be exempted from base-erosion-payment status to the extent that the foreign insurer has an obligation to pay a claim to an unrelated party.
- As a general rule, reinsurance payments must be viewed on a gross rather than net basis when determining the amount of base erosion payments made by an applicable taxpayer to a related foreign party.
- Insurance contracts are excluded from the qualified derivative payment exception to base erosion payment status.
- The recent adoption of the “BEAT waiver election” allows insurance companies that would otherwise qualify as applicable taxpayers to waive deductions and reductions in gross income for premiums or other consideration paid or accrued for (re)insurance that would otherwise be treated as base erosion tax benefits in order to remain under the threshold required for BEAT to apply.
- Foreign-based reinsurance multinational groups have reacted to the changes brought forth by the enactment of the BEAT by adopting innovative approaches to insurance risk allocation.
Introduction—Historical Background on U.S.-Foreign Affiliated Reinsurance
The decades leading to the enactment of the TCJA in 2017 saw overall growth in U.S. to foreign affiliate reinsurance arrangements.[3] This trend was accompanied by an increase in the number of corporate inversions beginning in the late 1990s, as a growing number of U.S.-based companies (including insurance companies) made the decision to reincorporate outside the United States.[4] These arrangements were perceived by some as permitting the shifting of profits on assets transferred to foreign affiliates outside the scope of U.S. income taxation.[5] In response, Congress took legislative action intended to address policy concerns related to the tax treatment of offshore affiliate reinsurance arrangements.[6]
The enactment of the TCJA in 2017 introduced significant changes to the taxation of multinational companies and cross-border transactions, including but not limited to offshore reinsurers and affiliates. The sweeping reform was intended to encourage multinational companies to remain or become U.S.-headquartered and to locate business operations in the United States through a variety of new provisions. The TCJA introduced a number of tax incentives including the reduction of the U.S. corporate income tax rate from 35 percent to 21 percent and the creation, as part of its participation exemption system, of a 100 percent dividends-received deduction (DRD) for certain non-U.S.-source dividends paid by ten percent-or-more-owned foreign subsidiaries. However, the TCJA also established the global intangible low-tax income (GILTI) regime and the BEAT, which imposed minimum taxes on certain foreign income and certain deductible payments made to foreign affiliates.
Notably, the TCJA did not repeal the FET payable on outbound insurance and reinsurance premiums. Thus, in addition to potentially attracting a BEAT liability, insurance and reinsurance premiums paid from U.S. insurers to foreign insurers and reinsurers with respect to risks located in the United States continue to be subject to the FET at the rate of 1 percent (reinsurance and life insurance) or 4 percent (P&C insurance), unless exempt under an applicable tax treaty.
Emergence of a Cross-Border Anti-Abuse Provision: The BEAT
One of the most dramatic changes to the U.S. international tax landscape came in the form of the BEAT, enacted under §59A. The BEAT is intended to protect the U.S. tax base from “base stripping” by imposing an additional tax on corporations making tax deductible payments to foreign related parties. The BEAT limits certain deductions and tax benefits (“base erosion tax benefits”) derived from deductible payments made to related foreign parties (“base erosion payments”).
The BEAT is essentially a 10 percent[7] minimum tax which may apply to a U.S. corporation or a U.S. branch of a foreign corporation with income that is effectively connected with a U.S. trade or business.[8] The BEAT applies in addition to other taxes imposed under the Code, including the regular corporate income tax and the FET.[9]
The BEAT is equal to the amount by which a U.S. corporation’s modified income tax liability, computed using a 10 percent rate and without taking into account certain deductible base erosion payments and net operating losses (NOLs) attributed to such payments, exceeds the U.S. corporation’s regular income tax liability after reduction for certain tax credits.
- For companies with NOL carryforwards, the BEAT effectively results in a 10 percent excise tax on any deductible outbound payments to related parties (and in some cases effectively a tax on the use of foreign tax credits).
- The BEAT applies even if the payment is made to a controlled foreign corporation (CFC) and its U.S. shareholder has a subpart F income inclusion.
- Certain tax credits have no effect on a taxpayer’s BEAT liability, and penalties for noncompliance with reporting requirements start from $25,000.[10]
On Dec. 13, 2018, Treasury and the Internal Revenue Service (“IRS”, the “Service”), released proposed BEAT regulations (the “2018 proposed regulations”).[11] On Dec. 2, 2019, Treasury and the IRS released final BEAT regulations (the “2019 final regulations”)[12] and additional proposed BEAT regulations (the “2019 proposed regulations”).[13] On Sept. 1, 2020, the Service released final BEAT regulations (the “2020 final regulations”)[14] which finalized the guidance provided in the 2019 proposed regulations and modified certain guidance provided in the 2019 final regulations.
Applicable Taxpayer
The BEAT applies only to certain large U.S. and foreign corporations that qualify as an “applicable taxpayer.” An applicable taxpayer with respect to any taxable year is a corporation with (1) average annual gross receipts of at least $500 million and (2) a base erosion percentage of 3 percent or higher.[15] The base erosion percentage threshold is dropped to 2 percent in the case of taxpayers that are members of affiliated groups containing a bank or registered securities dealer that generate more than a de minimis amount of income.[16] In applying the $500 million gross receipts test to a corporation that is subject to tax under subchapter L (i.e., the insurance tax provisions) of the Code, an insurance company’s gross receipts are reduced by return premiums but are not reduced by any reinsurance premiums paid or accrued.[17]
The numerator of the base erosion percentage is the company’s “base erosion payments,” as defined below. The denominator is all of the company’s deductible payments. With regard to insurance companies, the 2019 final regulations provide that claims payments are included in the denominator of the base erosion percentage except to the extent excluded from the definition of a base erosion payment.[18] Moreover, both the numerator and denominator for computation of the base erosion percentage expressly include reinsurance premiums paid by U.S. companies to foreign related parties, which are treated as reductions in gross income and thus are not technically “deductions” under subchapter L.[19]
Further, the BEAT rule and related regulations provide aggregation rules that take into account the gross receipts and expenditures of both the taxpayer and the taxpayer's aggregate group for purposes of determining applicable taxpayer status and, thus, whether the BEAT applies. The aggregation rules provide that all persons treated as a “single employer” under certain tax rules[20] will be treated as one person for purposes of determining applicable taxpayer status and for purposes of determining the base erosion percentage.[21]
Base Erosion Payments
A base erosion payment is any deductible amount paid or accrued by an applicable taxpayer to a related foreign party.[22] Section 59A(d)(3) specifically includes in the definition of base erosion payments any premium or other consideration for any reinsurance payments.[23] The BEAT extends to a variety of other related party payments, including deductible items such as interest, royalties and certain service payments, and applies even where transfer pricing standards are satisfied. Notably, the 2019 final regulations provide an exception from the definition of base erosion payment for payments to the U.S. branch of a foreign related person to the extent that the payments are treated as effectively connected income or meet a similar standard under a U.S. tax treaty (the “ECI exception”).[24]
Exception for Outbound Reinsurance Claims Payments
The 2018 proposed BEAT regulations did not provide specific rules for claims payments made by a domestic reinsurance company to a related foreign insurance company which, as identified by insurance industry comments, could have created a disparity of treatment of similar payments between life and nonlife insurance companies.[25]
In response to these comments, the 2019 final BEAT regulations provide for a specific exception from the definition of a base erosion payment for losses incurred and claims and benefits paid for reinsurance contracts, to the extent the amounts are paid or accrued to a regulated foreign insurance company[26] and are properly allocable to amounts required to be paid by such foreign company (or indirectly through another regulated foreign insurance company), pursuant to an insurance, annuity, or reinsurance contract, to a person other than a related party.[27] In other words, if a U.S. reinsurer makes a claims payment to an affiliated foreign insurer, the payment is not treated as a base erosion payment to the extent that the foreign insurer itself has an obligation to pay a claim to an unrelated party.
Netting with Respect to Insurance Contracts
The 2018 proposed BEAT regulations provided that, as a general rule, the amount of any base erosion payment is to be determined on a gross basis, regardless of any contractual or legal right to make or receive payments on a net basis.[28] Although several comments to the 2018 proposed regulations recommended that netting be permitted with respect to reinsurance contracts, Treasury and the IRS ultimately did not adopt a final rule that would permit netting in these circumstances, unless it would otherwise be permitted for U.S. tax purposes.[29]
Specifically, the 2019 final BEAT regulations require reinsurance payments to be viewed on a gross rather than a net basis when determining the amount of base erosion payments.[30] The Preamble to the 2019 final BEAT regulations provides that ceding commissions, reserve adjustments, claims payments or other expenses should not be netted against premiums ceded.[31] This treatment diverges from the contractual treatment for modified coinsurance, funds withheld arrangements and other reinsurance agreements that are settled on a net basis. Thus, for instance, any premium or other consideration paid or accrued by a U.S. taxpayer to a foreign related party for reinsurance is not reduced by or netted against other amounts owed to the U.S. taxpayer from the foreign related party or by reserve adjustments or other returns.[32] As a result, in the case of quota share arrangements, for example, the gross amount of reinsurance premium would be subject to the BEAT without taking into account any inbound payments such as reserve adjustments, ceding commissions, and claims payments.[33]
Qualified Derivative Payments—Exception Inapplicable to Insurance Contracts
Qualified derivative payments (QDP) are not base erosion payments.[34] The 2019 final BEAT regulations, however, expressly provide that the definition of “derivative” for this purposes does not include any insurance, annuity, or endowment contract issued by an insurance company to which subchapter L applies.[35]
Anti-Abuse Provisions
Within the framework of the BEAT, §59A(i) provides Treasury and the IRS with extremely broad authority to promulgate regulations to prevent the avoidance of the BEAT. Treasury and the IRS originally proposed three anti-abuse rules in December 2018.[36] In December 2019, the three original anti-abuse rules were finalized and a fourth was added relating to nonrecognition transactions.[37] Finally, two additional anti-abuse rules relating to partnerships were proposed in December 2019[38] and the final regulations that were published in October 2020 included these additional provisions.[39]
2020 BEAT Final Regulations—Insurance Highlights
Released on Sept. 2, 2020, the 2020 final BEAT regulations finalize the 2019 proposed regulations that were issued on Dec. 2, 2019 and revise certain provisions of the 2019 final regulations issued on the same date. The 2020 final regulations generally adopt the proposed election to waive deductions, the aggregate group rules, and the partnership rules of the 2019 proposed BEAT regulations. The final regulations also provide generally taxpayer-favorable refinements to the nonrecognition transaction anti-abuse rule introduced by the 2019 final regulations.
Election to Waive Allowable Deductions
Consistent with the 2019 proposed BEAT regulations, the 2020 final regulations provide a mechanism for taxpayers to waive deductions that otherwise would be base erosion tax benefits (the “BEAT waiver election”). Under the 2020 final BEAT regulations, this election is available only to a taxpayer that could be an “applicable taxpayer” but for the election.[40]
As part of the BEAT waiver election, the 2020 final BEAT regulations include a specific provision for the waiver of any premium or other consideration paid or accrued by an insurance company for any reinsurance payments that would be a base erosion tax benefit.[41] This provision represents a welcome change from the 2019 proposed regulations, which provided that the BEAT waiver election applied only to deductions, but not to reductions in gross income.[42] However, as noted in industry comments to the 2019 proposed rules, a base erosion tax benefit generally includes certain reductions to gross income related to reinsurance that may be treated as reductions to gross receipts, not deductions.[43] In response to such comments, Treasury and the IRS have determined that the BEAT waiver election should be equally available for such payments.[44]
The BEAT waiver election is potentially advantageous for certain corporations that currently qualify as applicable taxpayers, as it could allow them to bring their base erosion percentage below the three percent base erosion threshold at which the BEAT applies. Nevertheless, insurance-related base erosion payments that are waived under the BEAT waiver election remain subject to the FET.[45]
BEAT’s Impact on Global Reinsurance Business Models
At the time of its enactment in 2017, the BEAT was expected to materially limit the feasibility of offshore affiliated reinsurance arrangements and, ultimately, to cause such arrangements to be eliminated or significantly altered.[46] Foreign-based reinsurance multinational groups reacted to the enactment of the BEAT in a number of ways, including by (i) decreasing the size of their offshore intercompany reinsurance arrangements or eliminating them altogether; (ii) modifying the structure of their insurance arrangements; (iii) moving capital to onshore balance sheets; or (iv) forming new non-U.S. entities (or utilizing existing non-U.S. entities) that would subsequently elect under section 953(d) to be treated as U.S. taxpayers.[47]
The introduction of the BEAT was also expected to spur conversion of intercompany reinsurance ceded to offshore affiliates into reinsurance to unaffiliated insurance companies (i.e., third-party reinsurers). As the BEAT only applies to payments to foreign related parties, it was not expected to curtail third-party reinsurance.[48]
Conclusion
The enactment of the BEAT brought forth significant changes to the taxation of cross-border reinsurance transactions from both an inbound and an outbound tax perspective. Global reinsurance models have seen a need to adapt to such changes by adopting innovative approaches to insurance risk allocation. For instance, as predicted, the impact of the provisions of the TCJA, in general, and of the BEAT, in particular, is reflected in the reduction in U.S to foreign intercompany reinsurance arrangements and corporate inversions that has taken place since 2018.
The BEAT, along with other provisions enacted as part of the TCJA, is expected to maintain its position as a key element of the international tax landscape for years to come. Some of the TCJA’s international tax provisions have influenced the Organization for Economic Cooperation and Development’s (OECD) Global Anti-Base Erosion Proposal (“GloBE” or “Pillar Two”), which includes an income-inclusion rule that is similar to GILTI and an under-taxed payments rule that appears to borrow from the GILTI and BEAT regimes.
Acknowledgement
The author would like to thank Jason Kaplan and Jean Baxley for their valuable comments and substantial contributions. All errors remain those of the author. The views and opinions expressed in this article are those of the author and may not reflect the official position of Deloitte Tax LLP, its subsidiaries or affiliates.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.
Sandra Lopez P., Taxation LL.M. (Georgetown University Law Center), International Taxation LL.M. (Panthéon-Sorbonne University – Paris I), is a tax consultant II at the Financial Services Group at Deloitte Tax LLP in New York City. She can be reached at sandrlopez@deloitte.com.