A new analysis from the economic experts at the Penn-Wharton Budget Model (PWBM) confirms that international tax changes in the House’s Build Back Better Act would more than triple the residual tax the U.S. charges on U.S.-based multinational companies’ foreign earnings. More importantly, the analysis finds that a scenario in which the U.S. implements international tax changes and the rest of the world does not would put U.S.-based companies at a “meaningful competitive disadvantage” relative to other countries.
The latter finding requires lawmakers to rethink the implementation timeline of their proposed international tax changes, as the Build Back Better Act moves from the House to the Senate (and, potentially, back to the House). While the Biden administration is eager to have the Congress lock in these changes fast, in their pursuit of a global tax agreement negotiated with 130-plus countries at the Organisation for Economic Co-operation and Development (OECD), the PWBM analysis suggests that lawmakers would be wise to delay implementation of international tax changes until the U.S. has reasonable confidence other countries will hold up their end of the bargain on any agreement.
To be clear, NTU has expressed concern with the global tax negotiations writ large, and we have outlined numerous reasons we oppose the tentative agreement reached by 130-plus countries in July of this year. We believe a 15-percent global minimum effective tax rate would deny U.S. policymakers a significant degree of command and control over domestic corporate tax policy. Further, moving to a country-by-country assessment of these so-called ‘top-up’ taxes on foreign income would add to compliance and administrative burdens for companies and the IRS, while also denying the multinational reality of a 21st century economy.
That said, international tax changes are moving through the House and Senate fast, and Treasury Secretary Janet Yellen has expressed a desire to reach a final agreement on global minimum taxes some time in October. NTU hopes that if lawmakers are to make significant changes to the international tax regime in the coming month or two, they include provisions that minimize the potential burdens and harms to U.S. companies and workers, especially if the OECD agreement falls apart and the rest of the world fails to follow America’s lead.
Here are a few ways lawmakers can minimize the potential harm of the global tax agreement, short of opposing the ratification and implementation of the agreement in its entirety:
Delay implementation of the international tax changes until 2023: The tentative July agreement envisions the global minimum tax (Pillar Two) becoming effective in 2023. Given the uncertainty over whether key low-tax jurisdictions will join the agreement, and uncertainty surrounding the details of the final Pillar Two agreement[1] and the ratification and implementation of the agreement in more than 130 countries, the U.S. would be wise to delay the effective date, from January 1, 2022 to January 1, 2023. Such a change would still be compliant with Pillar Two, should the U.S. be party to the global tax agreement, would give U.S. policymakers an additional 12 months to monitor ratification and implementation of the agreement around the world, and would give U.S. companies time to plan for new tax and compliance burdens. PWBM experts stress that a scenario in which 1) the U.S. makes unilateral changes to comply with Pillar Two, but 2) the rest of the world does not follow suit, would put U.S. companies at a “meaningful competitive disadvantage.” They go on:
“Notably, foreign multinationals could continue to exploit tax havens to increase their profitability, while U.S. multinationals would not be able to take full advantage of such tax planning opportunities.”
Lawmakers should also explore some mechanism for pulling back from ratified international tax changes, should an insufficient number of other countries ratify the deal in 2022. To reduce the competitive disadvantages U.S. companies would face under the planned international tax changes, a large number of America’s economic competitors must faithfully execute on any global tax agreement reached this fall. If other countries don’t hold up their end of the bargain, it would be important for the U.S. to have a quick path out of the deal before it is made effective in 2023.
Include a substance-based carve-out that is as generous as the global agreement allows: Under the current law international tax regime (on Global Intangible Low-Taxed Income, or GILTI), U.S.-based multinational companies get to ‘carve out’ a portion of their foreign earnings and exclude those earnings from top-up taxation. That carve out is equal to 10 percent of the value of the tangible assets of a company’s foreign affiliate(s), or Qualified Business Asset Investment (QBAI). The policy rationale for the carve-out is that, with GILTI, the U.S. is attempting to tax the foreign profits earned from high-value, highly profitable, and easily movable intangible assets, like patents and trademarks, so the tax should not be assessed on the earnings a company receives from its tangible assets, like factories and equipment.
The tentative global tax agreement acknowledges the need for a substance-based carve-out, and suggests five percent of the value of a foreign affiliate’s tangible assets plus payroll.[2] Unfortunately, the House Build Back Better Act proposal is less generous than what OECD would allow (just five percent of tangible assets, half of the current-law amount), and the current Senate proposal envisions no carve-out (i.e., no QBAI) at all.
Instead, if the U.S. becomes party to a global agreement it should provide for a carve-out that is as generous as the global agreement allows. As of now, that means five percent of the value of tangible assets plus payroll, with a more generous 7.5 percent in the first five years (i.e., 2023-2027).
Include simplification options that reduce the compliance and administrative burdens of country-by-country GILTI calculations: As noted above, country-by-country calculations of GILTI liability will significantly increase compliance burdens for U.S.-based companies and administrative burdens for the IRS. While a globally ratified and implemented tax agreement would not disadvantage U.S. companies and administrators relative to economic competitors, in theory, the U.S. can and should pursue simplification options to country-by-country reporting that even the OECD has envisioned may be beneficial.
Here are two simplification options NTU envisioned in a previous letter to Senate Finance members:
“To specify a bit further, a safe harbor for GILTI tax liability calculations could apply to U.S. MNCs operating in jurisdictions with a minimum statutory or effective tax rate. For example, U.S. policymakers can be confident that a U.S. MNC paying an effective tax rate of 20 percent or more (according to already-existing requirements for MNCs to file country-by-country reports under OECD agreements) in a given country has complied with the global minimum, and does not need to do any further tax calculation work. Or the U.S. could include a profits de minimis threshold for top-up liability, so long as such a threshold is OECD-compliant, that suspends requirements to calculate tax liability in countries where a U.S. MNC is booking a minimal amount of total global pre-tax profits, such as 2.5 percent. We encourage lawmakers to pursue simplification options that will reduce compliance burdens for U.S. MNCs and administrative burdens for an already-overburdened IRS.”
We stand by these recommendations, and were disappointed to see the House Build Back Better language fail to include any simplification options related to country-by-country GILTI calculations.
We strongly encourage lawmakers to consider the above measures, which could reduce some of the harm done by international tax proposals currently making their way through Congress -- especially if the U.S. ends up going it alone. The PWBM analysis confirms, though, that whether by the House proposal, the Senate proposal, or a Pillar Two-compliant agreement, U.S. residual taxes on U.S. companies’ foreign earnings would rise significantly. That may be good news for lawmakers who want to bring in new tax revenue to pay for major spending programs under Build Back Better, but it will be bad news for U.S. companies -- who make investment decisions in part based on the statutory and effective tax rates of the U.S. versus its economic competitors -- and for U.S. workers who are affected by companies’ investment decisions.