Question

LearCo, a non-U.S. conglomerate, generates $4 billion in gross receipts annually. Its U.S. subsidiary, KingCo, accounts for $750 million of the annual gross receipts; KingCo’s average annual gross receipts for the last three years is $820 million. KingCo generates U.S. taxable income income of $180 million, after deducting a $350 million management fee that it pays to LearCo. KingCo reports no U.S. tax credits. The corporate income tax rate in LearCo’s country is 14%. What are the tax implications (if any) of this arrangement?

Answer 1

KingCo is subject to the base erosion tax.

• Its average annual gross receipts for the last three years are at least $500 million.

• Base erosion items are at least 3% of deductible items for the year ($350 million base erosion items ÷ $570 million total deductions = 61%). Total deductions of $570 million is the difference between gross receipts ($750 million) and taxable income ($180 million).

Now determine whether a base erosion tax is due. KingCo pays the greater of:

• Regular U.S. income tax: $37.8 million = 21% × $180 million taxable income, or

• The base erosion tax: $53 million = 10% × $530 million modified taxable income
($180 million taxable income + $350 million base erosion items).

Apparently tempted by the low tax rate of its parent LearCo, KingCo has shifted “too much” income to the non-U.S. country with its deductible management fee. It incurs the base erosion anti-abuse tax for the tax year. KingCo pays its regular U.S. corporate income tax of $37.8 million, plus the antiabuse tax equal to the excess amount of $15.2 million, for a total of $53 million. KingCo’s U.S. income tax liability has increased by about 30% due to the anti-abuse tax.