After three years of opposition and positioning that any global tax reforms be voluntary for US corporations under the Trump administration and Treasury Secretary Mnuchin, the Biden administration, Treasury Secretary Yellen and Senate Finance Committee Chairman Ron Wyden have reversed course and endorsed global tax reform in harmony with OECD proposals. In form, the US proposals are for changes in US domestic law that are intended to undo some of the perceived incentives arising under the tax changes introduced by 2017’s Tax Cuts and Jobs Act (TCJA) to move jobs, investment and research and development offshore while also raising the effective tax rate on US earnings at home and abroad. It is the later that aligns with the OECD proposals.
US corporate tax reform proposals
The Biden Administration proposal takes the form of a plan to revise US federal corporate income tax policy and law announced by the White House on March 31 (the “Made In America Tax Plan”) and a Treasury Department white paper released a few days later giving more detail in support of the Made in America Tax Plan. Senate Democrats on the Senate Finance Committee also published their own white paper making closely similar, although not identical international tax policy change recommendations.
The key proposals in the context of international taxation (1) are:
– Increasing the headline rate of US corporate income tax from 21% to 28%.
– Reducing the deduction for global intangible low taxed income (GILTI), from 50% of GILTI to 25% of GILTI (effectively bringing the pre-foreign tax credit US tax on GILTI from 10.5% to 21% under a 28% headline rate). (2)
– Eliminating the 100% dividends received deduction for dividends sourced from Controlled Foreign Corporation (CFC) income up to a 10% return on a CFC’s tangible property tax basis (QBAI).
– Introducing a country-by-country limitation on the availability of a foreign tax credit for 80% of non-US income taxes paid with respect to GILTI income.
– Repeal of the deduction for 37.5% of a US corporation’s “foreign derived intangible income” (FDII). (3)
– Repeal of the “base erosion alternative tax” or “BEAT” (BEAT), a corporate alternative minimum tax equal to the excess of (i) 10% of the US corporation’s taxable income recomputed by adding back certain deductible payments made to related non-US persons over (ii) such corporation’s liability for corporate income tax as regularly computed.
– Introduction of a new corporate alternative minimum tax on large US corporations equal to 15% of book income.
Many of these changes are seen as reversing incentives against US manufacturing investment introduced by the TCJA. As an example, both the complete exemption of foreign earnings on 10% of QBAI and the GILTI deduction on the remaining active income of CFCs (i.e., reduced taxation of non-US net income) and the FDII deduction’s starting point with 10% assumed return on QBAI have been seen to discourage investment in US plant and equipment, while incenting these investments in CFCs. The Biden administration plan would pair repeal of the FDII deduction with expanded credits for domestic R&D expenditures.
A new global minimum tax regime?
The proposed changes also form the basis for a global minimum tax regime. Reducing the deduction for GILTI to 25%, eliminating the 100% dividends received deduction for dividends sourced from a deemed 10% return on QBAI and introducing a country-by-country limitation on foreign tax credits against US federal tax on GILTI (thereby eliminating the ability to cross credit high taxed income and low taxed income) would result in a global minimum tax on a US corporation’s foreign earnings through CFCs of 21%.
Related changes to long-standing rules on expense allocation for purposes of foreign tax credit limitations and to an election included in recent Treasury regulations to exclude from GILTI a CFC’s income that is subject to a local income tax rate of at least 18.9% (under current law) (so-called “high taxed income”) are intended to incentivize US based research and development and IP ownership: worldwide allocation of US R&D expenditures may result in a larger amount of local tax (than if such expenses were incurred outside the US) and a more restrictive US limitation on crediting such taxes.
The proposal to repeal the BEAT is based on an understanding that this tax is rather random in its impact on US corporates and does not relate to whether the recipient of a deductible payment is subject to at least a minimum level of local tax on the payments. Additionally, the interaction of the BEAT with existing tax credits undercuts the incentives such credits were intended to provide for domestic activities. Instead, a new limitation on base erosion payments would apply where the payments are not subject to at least a minimum rate of local taxation in the hands of the recipient. In this regard, US domestic law reform also supports adoption of a minimum rate of tax in other countries (particularly the larger OECD economies).
Interaction with OECD project on taxation of the digital economy
While much of the direction of the proposed changes is towards a worldwide level of corporate minimum taxation (largely by eliminating the ability of low-taxed jurisdictions to operate as shelters for mobile income), these are not the same as the OECD project on taxation of the digital economy. That project focuses on the different question of how corporate profits generated from the digital economy should be allocated fairly to countries for purposes income taxation. While a generally level playing field on headline tax rates would reduce incentives to shift profits to specific countries or tax jurisdictions that are otherwise unconnected with the economic activities actually generating the profits, it is not at all clear that OECD member states will agree on the allocation rules that would apply to their corporates or to expat corporations selling digital services to their residents. Stated differently, the Biden administration tax reforms would advance and be aligned with Pillar 2 of the OECD’s 2019 proposals (i.e., the GloBE/BEPS2.0 proposal on creating a global corporate minimum tax), but would not necessarily be aligned with Pillar 1, the creation of a new taxing rights for market jurisdictions for specific, in-scope digital activities.
Currently, the Plan is limited to high level descriptions of its goals with key details yet to be determined. So, many questions about its exact operation remain. In addition, there are many uncertainties of how it will be received by Congress. The US Senate is currently evenly divided between Republicans and Democrats. Although the Democrats have a tie breaking vote in the event of any deadlock, it is uncertain if tax reform will be advanced using a budget reconciliation process that would allow a simple majority in the Senate and avoid a Republican filibuster or whether a sufficient coalition of Democrats (including all Senators) can be coalesced to assure passage even of a reconciliation package.
If US tax reforms along the lines above were enacted and other OECD countries did not raise their headline tax rates to comparable levels, the US changes could make inversions of US corporations more attractive (whereas the TCJA’s lower headline US tax rate had generally taken away the potential benefits of inversions). The Biden proposals would also implement new anti-inversion rules, potentially treating foreign acquiring corporations with as little as 50% US ownership as US tax residents based on place of effective management or operations.
(1) Other purely domestic changes have been proposed, including repeal of tax incentives that benefit fossil fuel producers and enhancing and making permanent tax incentives, such as new or expanded tax credits, for renewable energy projects, electric vehicle sales, carbon capture and electric transmission grid infrastructure that are seen as advancing the Biden administration’s climate-related commitments.
(2) GILTI is in substance the aggregate amount of a US shareholder’s pro rata share of the net income of the CFCs owned by such US shareholder other than (i) the subpart F income of such CFCs; (ii) a deemed 10% return on tangible assets of such CFCs and (iii) net income of such CFCs taxed an effective tax rate at least equal to 90% of the US rate (or 18.9%).
(3) Like GILTI, but with respect to US tangible assets and income, the starting point for computing a US corporation’s FDII is the amount of such US corporation’s net income in excess of a deemed 10% return on its QBAI. This excess is then treated as FDII in an amount equal to the fraction of the US Corporation’s worldwide income derived from sales of goods and services outside the US to total worldwide sales of good and services.