As the calendar nears September, Senate Finance Committee Chair Ron Wyden (D-OR), along with Senate Finance Committee colleagues Sherrod Brown (D-OH) and Mark Warner (D-VA), have released a discussion draft to reform how the U.S. taxes the foreign profits of U.S. multinational companies.
Though NTU’s experts and advocates are still analyzing various details of the proposal, and the accompanying 37-page draft bill text, we have a few early takeaways.
This proposal could make the U.S. tax code much less competitive than our economic peers in Europe and elsewhere: Two major features of the Wyden discussion draft might subject U.S.-based multinational companies (MNCs) to much higher taxes than MNCs based in Europe or in other parts of the world. First, Chair Wyden is proposing a higher rate on the profits of U.S. MNCs in certain low-tax jurisdictions, under the Global Intangible Low-Tax Income (GILTI) regime enacted under the Tax Cuts and Jobs Act (TCJA). The GILTI rate is currently 10.5 percent of profits earned abroad. That 10.5-percent rate is achieved by applying a 50-percent deduction to the statutory domestic corporate tax rate of 21 percent, which is assessed after exempting a 10-percent return on tangible assets.[1] GILTI functions as a top-up tax, so it only applies when MNCs have an effective tax rate on foreign profits that is below 10.5 percent. President Biden wants to double the GILTI rate to 21 percent, meaning the U.S. would assess a top-up tax whenever a foreign subsidiary of a U.S.-based MNC has an effective tax rate of less than 21 percent.[2] Chair Wyden wants to move the GILTI deduction, currently 50 percent off the statutory corporate tax rate, to some lower number, effectively raising the GILTI rate. For example, a 25-percent GILTI deduction off a domestic corporate tax rate of 25 percent would make for a GILTI rate of 18.75 percent.[3] Unfortunately, any statutory GILTI rate that is north of 15 percent may mean the U.S. taxes foreign profits of MNCs at a higher rate than economic peers. And, as Senate Finance Committee Republicans recently noted, the nonpartisan Joint Committee of Taxation found, in an April 2021 report, that the GILTI tax rate on 81 of the largest U.S.-based corporations in the 2018 tax year was 16 percent -- already higher than the proposed 15-percent minimum.[4] The Biden administration’s proposal, on the other hand, could make the statutory U.S. GILTI rate 40 percent higher than similar tax rates in other nations. Because of the FTC haircut (discussed below), the effective GILTI rate could go as high as 26.25 percent for some MNCs -- 75 percent higher than the global minimum.
The second major feature of Chair Wyden’s proposal that might subject U.S. MNCs to much higher rates than MNCs based in other countries is the proposed elimination of the qualified business asset investment (QBAI) exemption in GILTI. QBAI effectively exempts 10 percent of a company’s adjusted bases in tangible assets from the amount of foreign profits taxed under GILTI. As we explained in the first footnote, the legislative intent of QBAI is to focus GILTI taxation on an MNC’s return from high-value and highly mobile intangible assets booked abroad, like intellectual property, rather than an MNC’s return from tangible assets like factories, machinery, and equipment. Unfortunately, repealing QBAI could leave the U.S. as one of the few countries in the global minimum tax deal without a so-called “substance-based carve-out” for MNCs subject to taxes on foreign profits. The July agreement between more than 130 countries calls for a “formulaic substance carve-out” equal to “at least” five percent of tangible assets and payroll. The nonpartisan Tax Foundation has estimated that replacing QBAI with the global agreement-compliant carve-out, when combined with other agreement-compliant changes to U.S. international tax law, would only increase revenues by $2.7 billion over 10 years (effectively a revenue-neutral proposal). Repealing QBAI without a replacement, on the other hand, could raise taxes on U.S. companies by tens of billions of dollars over a decade and make the U.S. a less tax-competitive location for business than economic peers in Europe.[5]
This proposal is designed with the size of the tax hike first in mind, and simplicity and certainty a relative afterthought: Though Chair Wyden and his colleagues make some efforts at simplifying the international tax regime in their discussion draft, such as applying any foreign tax credit (FTC) haircut and and country-by-country rules to subpart F income and foreign branch income (and not just GILTI), it’s clear that increasing tax collections is first and foremost in the lawmakers’ minds. Chair Wyden said that this proposal “would generate critical revenue” and “is central to our efforts to restore fairness and fund critical investments like the paid leave and the expanded child tax credit.” Unfortunately, such an approach violates an important principle for designing tax policy: focus on simplicity and certainty first, and potential revenue increases last. Or, as NTU President Pete Sepp put it to the OECD when NTU weighed in on the global tax negotiations: “No international tax framework can function with simplicity and certainty for long if it is designed with the overriding goal of merely raising additional revenues.”
The central feature of Chair Wyden’s proposal that will increase the complexity of international tax compliance for U.S. MNCs is a move to country-by-country calculations under GILTI. Under current law, U.S. MNCs blend the effective tax rates in all their global operations together to come up with one effective tax rate on foreign profits, with GILTI assessed if the effective tax rate falls below the 10.5 percent GILTI rate. This makes calculating and assessing GILTI easier for both companies and the IRS, and keeps GILTI focused on a worldwide average of tax rates.
Chair Wyden’s proposal would have GILTI assessed in any jurisdiction where a company’s effective tax rate is less than the (yet-to-be-determined) GILTI rate, with countries where a company pays more than the GILTI rate excluded as “high-tax tested income.” Companies would be able to blend multiple business units in a single country, but not business units in multiple countries.[6] Tax Foundation’s Daniel Bunn has pointed out that country-by-country GILTI would raise compliance burdens for companies and administrative burdens for IRS agents. The Wall Street Journal editorial board similarly says country-by-country would be “complex and expensive” for companies and “would drown tax bureaucrats” in paperwork, while also punishing companies with loss-making subsidiaries.[7] What country-by-country calculations would do, in Tax Foundation’s estimate, is raise taxes by tens of billions of dollars over a decade -- $45.2 billion under the Biden proposal. This is poor tax policymaking, apparently focusing on revenues first and simplicity last.
The tax hikes in the proposal could be exacerbated by leaving a foreign tax credit (FTC) haircut in place: One of the flaws of the current-law GILTI regime is that it limits the amount of foreign taxes a U.S. MNC can use to offset their GILTI liability; the so-called FTC haircut. Specifically, it allows a U.S. MNC to only apply 80 percent of their foreign taxes to offset GILTI. This means effective tax rates in some jurisdictions are higher than GILTI’s 10.5-percent statutory rate, and can go as high as 13.125 percent. Chair Wyden’s discussion draft envisions possibly leaving the 20-percent FTC haircut in place, or possibly eliminating the FTC haircut altogether, or possibly having some FTC haircut smaller than 20 percent. Lawmakers should repeal the FTC haircut; otherwise, the effective GILTI rate will actually be higher than the statutory rate in many cases. As noted above, under the Biden proposal GILTI rates could go as high as 26.25 percent in some jurisdictions, exacerbating the tax hike (especially in combination with the repeal of QBAI without a replacement).
A better proposal would keep rates low and would maximize simplicity: NTU recently made a number of suggestions to the Treasury Department as it seeks to wrap up global tax negotiations by October. Those recommendations are relevant to Chair Wyden and Senate Finance members as well, as lawmakers put their thumbprint on the Biden administration’s international tax reform efforts:
- Ensure the GILTI rate is no higher than what’s needed to comply with Pillar Two. This could be a 15-percent GILTI rate, along with repeal of the FTC haircut and allowance for loss carryforwards.[8] As already noted though, effective GILTI rates in 2018 for more than 80 large U.S. companies was 16 percent. Lawmakers contemplating a higher GILTI rate should pay attention to additional GILTI design choices, such as country-by-country calculations, FTC haircuts, and loss carryforwards, that could push the effective tax rate under GILTI higher than the statutory 15 percent.
- Keep a substance-based carve-out: Repealing QBAI without a replacement would be a major concession to European countries, and other U.S. economic peers, in the global competition for multinational companies’ investments. If the global tax agreement envisions a substance-based carve-out for compliant countries, the U.S. should maintain a substance-based carve-out -- even if it doesn’t exactly match QBAI.
- Heed stakeholder warnings about country-by-country calculations. By insisting on country-by-country calculations at global tax negotiations, the Biden administration and lawmakers may put U.S. MNCs in a difficult position when the time comes to implement any global tax agreement. Absent the administration’s willingness (or lawmakers’ willingness) to push back on country-by-country calculations at this late stage of global negotiations, lawmakers should contemplate safe harbors, de minimis thresholds, or other simplification measures that would ease the reporting burden on U.S. MNCs and the administrative burdens on an already-overburdened IRS. The OECD envisions such simplification options in the global agreement, and all center somewhat on the country-by-country quandary.
Though global negotiations appear to be at a late stage, it is not too late for lawmakers to make their views clear to the Biden administration. International tax reform should be completed with U.S. economic, job, and wage growth (and competitiveness) first in mind, followed by simplicity and certainty in the tax code. Potential tax revenue gains should be a tertiary consideration, and international tax reform should not be seen as a way to pay for massive new spending priorities.
[1] This carve-out is meant to focus GILTI taxation on an MNC’s return from high-value and highly mobile intangible assets booked abroad, like intellectual property, rather than an MNC’s return from tangible assets like factories, machinery, and equipment. More on the carve-out later in this section.
[2] Limitations on an MNC’s ability to offset their GILTI tax liability with foreign tax credits (FTCs), also called the FTC haircut, raise the effective rate on GILTI from 10.5 percent to as high as 13.125 percent. The Biden proposal to raise the statutory GILTI rate to 21 percent, without changes to the FTC haircut, could raise effective GILTI rates from 21 percent to as high as 26.25 percent. More on the FTC haircut in a subsequent section.
[3] The calculation is as follows: Corporate tax rate - (Corporate tax rate * GILTI deduction) = GILTI rate. In this case, that would work out to: 25 - (25*.25) = 18.75 percent.
[4] The 2018 tax year is the most recent year for which JCT had IRS data to analyze, and 2018 was the first year GILTI was in effect. See page 63 of the JCT report.
[5] European Union law suggests European countries’ agreement-compliant tax changes will need to include a substance-based carve out. As Bloomberg has reported: “EU law established in the Cadbury Schweppes case that CFC rules that don’t have a carve-out for real economic substance in a jurisdiction violate the Treaty of the Foundation of the European Union. The treaty is the basis for EU law and established the principle of free movement of capital.”
[6] For example, say U.S. MNC “Alpha” has three subsidiaries in two countries -- Alpha Ireland 1, Alpha Ireland 2, and Alpha Germany. Alpha, the U.S.-based parent company, would blend its income and losses from Alpha Ireland 1 and Alpha Ireland 2 to come up with its effective tax rate for Ireland, but could not blend Alpha Ireland 1 with Alpha Germany, or Alpha Ireland 2 with Alpha Germany, or the combined Alpha Ireland 1 and Alpha Ireland 2 effective tax rate with Alpha Germany.
[7] From WSJ: “A flaw in the 2017 version of Gilti—which the Biden plan leaves in place—is that it doesn’t allow companies to carry losses forward or back. This is possible for most other provisions in the corporate tax code, and it’s vital for investment. … But under Gilti, if an American company starts a new subsidiary in high-tax Italy that makes losses its first few years, that company still will owe tax in the subsidiary’s first profitable year.”