The Tax Cuts and Jobs Act of 2017 (“TCJA”) marked the most dramatic revision to the U.S. tax code in decades. Several TCJA provisions affected the U.S.’s international tax rules. However, none were more innovative than the Base Erosion and Anti-Abuse Tax (“BEAT”). The BEAT combats base erosion and profit shifting (“BEPS”), strategies employed by multinational corporations (“MNCs”) that shift profit from high to low tax jurisdictions to minimize global tax liability. Countries have traditionally controlled BEPS by amending their tax rules to eliminate the availability of specific practices and by monitoring transactions between an MNC’s international affiliates (“cross-border transactions”) to ensure they were made at arm’s length. Innovatively, the BEAT combats BEPS by requiring MNCs to recalculate their taxable income entirely excluding deductions from certain cross-border transactions historically associated with BEPS. If tax liability on this modified taxable income is greater than an MNC’s regular tax liability, the MNC must pay the difference.
This article discusses the BEAT’s consistency with three areas of international tax law—U.S. bilateral tax treaties, World Trade Organization (“WTO”) rules, and the Organisation for Economic Co-Operation and Development’s (“OECD”) BEPS Action Plan—and why, even if the BEAT is inconsistent, the U.S. is unlikely to face repercussions. To begin, the BEAT arguably violates the U.S. Model Income Tax Convention (“U.S. Model”), the basis for all of the U.S.’s bilateral tax treaties. The U.S. Model’s Savings Clause protects many of its provisions from violation; however, the Savings Clause does not cover Article 24, its non-discrimination provision, which prohibits the U.S. from treating domestic entities more favorably than entities from its treaty partner’s jurisdiction. The BEAT may violate Article 24 by requiring MNCs, when recalculating taxable income, to exclude deductions from certain cross-border transactions while allowing deductions for equivalent transactions when made between MNCs’ domestic affiliates. Some scholars claim this discrimination “falls squarely within the ambit of [A]rticle 24.” Others disagree, arguing that, because MNCs may deduct cross-border transactions when calculating their regular tax liability, the BEAT’s discriminatory treatment does not violate Article 24. Furthermore, even if the BEAT is inconsistent with Article 24, the BEAT may override U.S. bilateral tax treaties because the U.S. applies a last-in-time principle when determining whether treaties or legislation prevails.
Additionally, the BEAT may violate WTO rules. Most discussion regarding the BEAT’s consistency with WTO rules surrounds violations of the WTO’s Agreement on Subsidies and Countervailing Measures (“SCM Agreement”). As its name implies, the SCM Agreement regulates countries’ use of subsidies and countervailing measures against other countries’ subsidies. A subsidy must meet two requirements to violate the SCM Agreement. First, the subsidy must satisfy the SCM Agreement’s definition of a subsidy: a financial contribution by a government that confers a benefit. Second, the subsidy must be specific. The specificity requirement is satisfied if the subsidy is selectively provided to an enterprise, industry, or region, or if the subsidy is one of two types of “Prohibited Subsidies,” which are presumed to be adverse to trade and per se specific.
Two aspects of the BEAT are arguably inconsistent with the SCM Agreement. First, when recalculating taxable income, the BEAT requires MNCs to exclude deductions for imported depreciable property. This creates an implicit subsidy that incentivizes MNCs to use domestic depreciable property, which is deductible under the BEAT, over foreign depreciable property. While this subsidy meets the SCM Agreement’s definition of a subsidy and is a Prohibited Subsidy that is per se specific, scholars are skeptical that deductions for imported depreciable property are substantial enough to warrant WTO challenges. Second, the BEAT requires MNCs that have recently inverted (i.e., shifted their parent to a foreign, low tax jurisdiction) to exclude reductions for cost of goods sold (“COGS”). Like with imported depreciable property, this exclusion operates as an implicit subsidy that both meets the SCM Agreement’s definition of a subsidy and is a Prohibited Subsidy. However, once again, scholars are skeptical that the subsidy is substantial enough to warrant WTO challenges, given the exclusion only applies to inversions made after November 2017 and the U.S.’s definition of inversion is relatively easy to avoid.
Finally, the BEAT arguably frustrates the OECD’s BEPS Action Plan. This plan, which is the result of a collaborative effort among countries to combat BEPS, prescribes fifteen actions for ensuring MNCs’ profits are taxed in the countries where they perform their profit-generating activity. The BEAT conflicts with several of the plan’s actions. For example, Actions 8-10: Transfer Pricing emphasize the importance of the arm’s length method, which requires affiliates to transact as if they were unaffiliated, in evaluating cross-border transactions. With affiliates acting at arm’s length, transfer prices are theoretically set fairly and MNCs’ profits are taxed in the countries where they perform their profit-generating activity. The BEAT’s innovative approach to combating BEPS abandons the arm’s length method, instead requiring MNCs to entirely exclude certain cross-border transactions when recalculating their taxable income. Additionally, the BEAT conflicts with Action 15: Multilateral Instrument, which calls for countries to sign a multilateral instrument agreeing to modify bilateral tax treaties to reflect the OECD’s BEPS Action Plan. To date, the U.S. has not signed the multilateral instrument, and with the BEAT, signaled an intention to combat BEPS unilaterally. Absent participation in the multilateral instrument called for in Action 15, the OECD’s BEPS Action Plan is no more than international soft law for the U.S. In sum, the BEAT, while an innovative approach to combating BEPS, may violate U.S. bilateral treaties, WTO rules, and the OECD’s BEPS Action Plan. However, even if the BEAT is inconsistent with these areas of international law, the U.S. is unlikely to face repercussions for the reasons discussed above.
Alex is a student at Columbia Law School. He holds a B.B.A. in finance from the University of Notre Dame and previously spent four years providing advisory services to corporations facing disputes and investigations. Alex also has experience paying taxes.