International Tax Reform in 2021: A Look at the Biden Administration Proposals and the Senate Finance Committee Framework
Both the Biden Administration (the “Administration”) and the Senate Finance Committee (“SFC”) have released proposals that would make significant changes to the tax rules enacted in 2017 as part of the Tax Cuts and Jobs Act (“TCJA”). Although the Administration’s Plan and the SFC’s Plan both address the same key areas of corporate income tax, there are differences in the two proposals. The consensus, however, appears to be growing that changes to the tax reforms that were included in the TCJA are likely to be advanced in 2021.
The main drivers behind these proposals are – (1) revenue requirements to offset the infrastructure legislation being developed by the Administration and Democratic Congressional leaders (the American Jobs Plan), and (2) reform of the international tax rules that were enacted in the TCJA. The goal of the latter is described within the proposal as an effort to encourage companies to keep jobs and investment in the United States.
In addition, the US is expected to actively participate in discussions with the Organization for Economic Co-operation and Development (“OECD”) that may result in major changes to the global tax rules, assuming a consensus is reached by the target date set of mid-summer. Treasury Secretary Yellen has given clear signals that the US plans to work with other countries on these issues, including expressing support for a global minimum corporate tax rate. As noted below, these discussions are being had in tandem with the proposals from the Administration and the SFC in the international area.
This True Alert will highlight the key takeaways for businesses in these new proposals. Business taxpayers should review and monitor these tax developments as legislation is developed. The committees in charge of preparing the legislation are aiming for likely inclusion in the infrastructure and economic recovery legislation that Democratic leaders expect to present by this summer.
The Biden Administration – Made in America Tax Plan
On March 31, 2021, the Biden Administration released their American Jobs Plan, which is a tax and spending proposal designed to address infrastructure issues and job creation. It addresses a variety of issues including spending for roads and bridges, the electric grid, broadband capacity, and water systems; the promotion of clean energy; the expansion of affordable housing; incentives for domestic manufacturing; and home and community based care for children, the elderly, and individuals with disabilities. The $2.3 trillion package would be offset by the Biden Administration’s Made in America Tax Plan, which was released concurrently with the American Jobs Plan.
On April 7, 2021, the Treasury Department released a report on the Made in America Tax Plan (“Administration Plan”), which provides additional detail on the Administration’s tax proposals. The Made in America Tax Plan provides for corporate-related tax increases, including raising the corporate tax rate to 28% (from the current 21%) and repealing or restricting certain current-law tax incentives. The Administration is expected to submit its Fiscal Year 2022 budget to the Congress in May, including a Treasury “Green Book,” which in the past has been the blueprint for specific tax proposals suggested by the White House.
Key business issues in the Made in America Tax Plan include:
- Increase the corporate tax rate to 28%;
- Impose a 15% minimum tax on the book income of “large corporations” (undefined in the proposal);
- Changes to the global intangible low-taxed income (“GILTI”) regime:
- Increase the effective tax rate on GILTI to 21% (from 10.5%),
- Remove the 10% exemption for tangible assets owned abroad, and
- Require that the income inclusions be calculated on a country-by-country basis instead of in the aggregate;
- Eliminate the deduction for foreign-derived intangible income (“FDII”)
- Repeal the Base Erosion and Anti-Abuse Tax (“BEAT”) and replace it with the Stopping Harmful Inversions and Ending Low-tax Developments (“SHIELD”) which disallows tax deductions for payments made from the US to related parties in low-tax jurisdictions; and
- Proposals designed to address offshoring and inversions.
The Administration Plan explained the proposed international changes as follows:
One of the most important objectives of the Made In American tax plan is to reduce incentives for the offshoring of American jobs while also limiting the ability of corporations to take advantage of corporate tax loopholes to shift their profits to low-tax jurisdictions.
The plan takes aim at offshoring through a series of reforms that reverse tax-based incentives for moving production overseas. Perhaps the most consequential of these are fundamental changes to the GILTI regime introduced by the TCJA … The President’s plan would dramatically reduce the significant tax preferences for foreign investment relative to domestic investment that are embedded in both the current GILTI and FDII regimes … In parallel to these efforts to eliminate profit shifting by US multinational companies, proposals to repeal and replace the Base Erosion and Anti-Abuse Tax (BEAT) would counter the profit shifting of foreign-headquartered multinational companies. All told, these proposals would bring well over $2 trillion in profits over the next decade back into the US corporate tax base.
Senate Finance Committee “Overhauling International Taxation” Report
On April 5, 2021, Senate Finance Committee Chairman Ron Wyden (D-OR) released a white paper titled “Overhauling International Taxation: A framework to invest in the American people by ensuring multinational corporations pay their fair share” (“SFC Plan”). The plan was jointly released with Senator Sherrod Brown (D-OH) and Senate Mark Warner (D-VA), who are both members of the Senate Finance Committee.
The SFC Plan includes high-level recommendations and options, but it does not include detailed proposals or specific tax rates. Chairman Wyden requested that comments on international changes discussed in the SFC Plan be sent to InternationalTax@finance.senate.gov no later than April 23rd.
The Senate Finance Committee held a hearing on March 25, 2021 on international taxation with the intention of initiating a review of several key issue areas that were enacted as part of the TCJA: GILTI, FDII, and the BEAT. Chairman Wyden began the hearing by outlining these principles:
First, multinationals must pay a fair share, just like Americans who work for a living. There were too many corporate loopholes and opportunities for gamesmanship before the Trump tax law….Rates are too low, and it’s too easy for corporations to skip out on paying a fair share by gaming the system and shifting profits; and
Second, the tax code must reward companies that invest and create good-paying jobs in the US, and stop rewarding companies that ship jobs and factories overseas….The provisions of the Trump tax law that shortchange American workers and make us less competitive have got to go.
Chairman Wyden also cited concerns with the still-prevalent use of tax havens, which was outlined in a report that was issued by Joint Committee on Taxation for the hearing.
Treasury Support of a Global Minimum Tax – the OECD Talks
On April 5, 2021, Treasury Secretary Yellen made a speech to the Chicago Council on Global Affairs and wrote an op-ed in the Wall Street Journal advocating for a global minimum tax, which is one of the key elements of the Made in American Tax Plan. Secretary Yellen said:
President Biden’s proposals announced last week call for bold domestic action, including to raise the US minimum tax rate, and renewed international engagement, recognizing that it is important to work with other countries to end the pressures of tax competition and corporate tax base erosion.
We are working with G20 nations to agree to a global minimum corporate tax rate that can stop the race to the bottom. Together we can use a global minimum tax to make sure the global economy thrives based on a more level playing field in the taxation of multinational corporations, and spurs innovation, growth, and prosperity.
The US made a presentation at the OECD Steering Group of the Inclusive Framework in early April that outlined its negotiating position on the current Pillar One and Pillar Two concepts, which are part of the OECD project with “blueprint” documents on the two pillars released in October 2020.
- Pillar One would create new income apportionment and nexus rules to allow jurisdictions to tax certain multinational companies on income earned in jurisdictions where such multinationals may not maintain a physical presence.
- Pillar Two would create a global minimum tax.
The presentation confirms the Administration’s support for Pillar Two of the project and outlines the Administration’s legislative proposals to adopt an OECD-compliant minimum tax in the US. The US also committed to:
- Reform the GILTI regime to align with the Income Inclusion Rule more closely, which is part of the Pillar Two approach, including by adopting a country-by-country foreign tax credit limitation, and
- Repeal the US BEAT and replace it with a regime resembling the Undertaxed Payments Rule, which is also part of the Pillar Two approach. These proposals are further discussed below as part of the Administration Plan to reform both GILTI and the BEAT.
The presentation also proposes a new approach on Pillar One which is intended to simplify the OECD’s existing proposals and avoid perceived discrimination against US multinationals. The new approach includes a 21% global minimum tax that would apply to companies that meet revenue and profit-margin thresholds regardless of their industry and whether they are consumer-facing or not. The result is that the proposal would focus on no more than 100 of the world’s most profitable multinationals, and thereby eliminate business line segmentation. The US also indicated that it is “prepared to be flexible” in other areas, including new nexus rules, to reach consensus and provide benefit to developing countries.
Reaction from other key players in the discussions, including France, Germany, the Netherlands, and the UK, has been positive to this development. The OECD has recently stated that the goal is to reach a political agreement for a global consensus-based solution by the G20 Finance Ministers meeting scheduled for July 9-10, 2021.
Global Intangible Low-Taxed Income (GILTI)
Current Law: The GILTI regime imposes a 10.5% minimum tax on 10-percent US corporate shareholders of “controlled foreign corporations” (“CFCs”) based on the CFC’s income in excess of a threshold equal to 10% of the CFC’s tax basis in certain depreciable tangible property (so-called “qualified business asset investment” or “QBAI”). GILTI is included in currently taxed income of the US shareholder, but a 50% deduction for this income is allowed for corporate taxpayers in taxable years beginning after December 31, 2017, and through tax years beginning before January 1, 2025. This income inclusion and 50% deduction results in a 10.5% effective tax rate at the current 21% corporate tax rate. For taxable years beginning after December 31, 2025, the deduction is to be reduced to 37.5%, resulting in a higher effective tax rate on GILTI inclusions of 13.125%.
GILTI is determined on an aggregate CFC basis, so that a US multinational corporation may offset income earned in one jurisdiction with losses incurred in other jurisdictions. This aggregate approach allows for a potential “blending” of income earned in the low tax rate countries with income from high tax-rate countries.
Administration Plan: The Administration Plan includes the following proposals, which are estimated to increase revenue by $500 billion over 10 years:
- Increase the effective tax rate on GILTI to 21% (from the current rate of 10.5%)
- Require GILTI to be calculated on a country-by-country basis; and
- Change the formula for calculating GILTI to eliminate the exclusion for a 10% return on foreign tangible investment (QBAI).
Treasury Secretary Yellen has referred to these proposals when expressing her support of the effort to reach a consensus on a global minimum corporate tax at the OECD talks. The US proposal states that the Biden Administration is encouraging other countries to also adopt minimum taxes on corporations so that foreign corporations are not advantaged and foreign countries cannot try to get a competitive edge by serving as tax havens.
SFC Plan: Proposals in the SFC Plan include:
- Increasing the effective tax rate on GILTI, leaving open the question of whether the rate should be equal to the US corporate rate or continue to be at a lower proportion of the US rate, as proposed in the Administration Plan;
- Requiring GILTI to be calculated on a country-by-country basis, either by expanding the existing system of foreign tax credit “baskets” to have separate GILTI “country baskets” or by dividing global income into low-tax and high-tax categories and applying GILTI only to income from low-tax jurisdictions;
- Revisiting guidance issued by the prior Administration to provide a “mandatory high-tax exception” to target offshore tax haven abuse by multinational corporations;
- Eliminating the exclusion for a 10% return on QBAI; and
- Treating US research and development expenses as entirely domestic, which would eliminate foreign tax credit penalties under GILTI.
TPC Observation: A key issue will be the new effective tax rate and whether it is equal to or lower than a potentially new increased US corporate tax rate. The SFC Plan suggests that the rate will depend on the US corporate rate and base stripping proposals. The proposed requirement that GILTI be calculated on a country-by-country basis will likely result in an increase in US tax liability for US multinationals.
The SFC Plan to use the GILTI high-tax exception in the current regulations is an unexpected approach. Treasury first proposed the GILTI high-tax exception in June 2019, and it was finalized in regulations published in July 2020. The rule was a response to concerns among corporate taxpayers that the GILTI tax often applied to income already taxed at rates higher than 13.125%, due to foreign tax credit limits. Treasury decided to use an existing GILTI and Subpart F exclusion to offer companies the choice to exempt income from the GITLTI tax if it had been taxed by a foreign jurisdiction at 18.9% or higher (90% of the current corporate tax rate). The regulations were criticized by many that they were not authorized by the statute. The SFC Plan states, “While the regulations were a dubious interpretation of current tax laws, the vast majority of these rules can be co-opted in a mandatory high-tax exclusion, but in a more effective and fair system,” then adds, “Instead of providing a back-end regulatory tax cut (which the Trump regulations did), these rules can instead be flipped on their head to target offshore tax haven abuse by multinational corporations.”
Foreign-Derived Intangible Income (“FDII”)
Current Law: The FDII regime allows a deduction intended to provide a lower tax rate on intangible income produced in the US but derived from abroad. It provides a lower 13.125% effective tax rate (before January 1, 2025) for certain foreign sales and the provision of certain services to unrelated foreign parties in excess of 10% of the taxpayer’s domestic QBAI. One of the primary criticisms of FDII is that it would probably violate the World Trade Organization rules against export subsidies.
Administration Plan: The Administration Plan would repeal the deduction for FDII based on the rationale that the FDII’s QBAI concept creates an incentive to move tangible investment out of the US. The Treasury Report argues that because the FDII benefit is only received above a 10% return on a domestic corporation’s tangible assets, companies can lower the hurdle necessary to obtain preferential FDII treatment by reducing tangible investments in the US.
SFC Plan: The SFC Plan would repeal the QBAI concept in the FDII regime rather than repealing FDII altogether. It also proposes replacing the “deemed intangible income” concept within FDII with an approach referred to as “deemed innovation income (“DII”) that would be designed to encourage spending on US-based research and development and worker training. There would be a lower effective tax rate on DII, which would be determined by reference to expenses for “innovation-spurring” activities that occur in the US, such as research and development and worker training. No additional details are given on this proposal, and it is unclear how the revised regime would interact with existing incentives, such as deductions for research and development.
The SFC Plan also recommends that if the new system includes both modified GILTI and FDII regimes, that the two systems should have equal tax rates, unlike the current system which dictates a 10.5% rate on GILTI and a 13.125% rate on FDII.
TPC Observation: The FDII regime was originally introduced by the TCJA as an effort to incentivize the retention of income-producing activities in the US. Under both the Administration and SFC Plans, there are indications that benefits of domestic production and innovation will not be completely erased. Whether that will take place as part of an entirely new set of rules or as part of an update to existing guidance remains to be seen. If the former scenario prevails, companies will have to take a new look at their specific facts to determine if they still qualify, no longer qualify, or newly qualify.
Base Erosion and Anti-Abuse Tax (“BEAT”)
Current Law: The BEAT generally provides for an add-on minimum tax, currently at 10%, on certain deductible payments that are made by very large US corporations to related foreign parties. This regime has been criticized for not preventing base erosion and for affecting companies that are not engaged in tax abuse. Other countries have encouraged the US to drop the BEAT as part of the OECD negotiations, arguing that it is not consistent with tax treaties and that it targets cases that are not necessarily tax-abusive.
Administration Plan: The Administration Plan proposes replacing the BEAT regime with the SHIELD regime, which is estimated to raise $700 billion over 10 years. This proposal is designed to attack earnings stripping, which is a practice by which certain payments to a foreign affiliate have the effect of shifting earnings from the US to another country. This regime would deny US deductions on related-party payments if they are subject to a low effective rate of tax in the destination jurisdiction. The Administration Plan states that the BEAT has been ineffective in preventing profit shifting, and that it unfairly penalizes US-based taxpayers that benefit from certain tax credits.
The Administration Plan also states that what constitutes a “low effective rate of tax” could be determined as part of the current negotiations ongoing at the OECD as part of the Inclusive Framework on Base Erosion and Profit Shifting. Absent such an agreement, the rate would be equal to the proposed rate in the Administration Plan on GILTI. The Administration Plan includes the suggestion that US adoption of the proposed SHIELD regime would encourage other countries to adopt their own minimum tax regimes so that their resident companies would be less likely to be subject to the US SHIELD regime.
SFC Plan: Rather than repealing the BEAT, the SFC Plan would create a second rate bracket that would be higher than the 10% rate with the second rate applying to base erosion payments as opposed to regular taxable income, which would continue to be subject to the 10% rate. It also proposes that changes be made to provide full value for domestic tax credits, although the SFC Plan does not include details that would explain how calculation of the BEAT would be changed to produce this result. Finally, it suggests that problems that are created from the interaction of the BEAT and foreign tax credits be addressed if revenue is available to do so from the creation of the second BEAT rate bracket.
TPC Observation: Similar to the approach of the SFC Plan for FDII, the existing framework for the BEAT would be altered to tax perceived abusive transactions. This differs from the Administration Plan that would completely alter the taxing structure of these base erosion payments. The internal administrative burden of implementing new tax laws will weigh heavy on corporate tax department, even as they continue to incorporate the final regulations of the TCJA overhaul.
Both plans seem to support the push towards a global minimum tax, which may raise the income tax burdens of corporate taxpayers around the globe. Companies should begin taking a look at their income tax footprint, particularly for operations within OECD countries that have historically had low tax rates.
Offshoring & Inversions
Current Law: Under current law, US corporations can acquire or merge with a foreign company to minimize US taxes by claiming to be a foreign company, even though their places of management and operations are within the US. Currently, inversions rarely take place due to the 2017 law changes and regulations that were issued during the Obama Administration. It is possible that the current Administration anticipates renewed interest in inversions, however, in light of some of the new proposals in the international area that may increase interest in establishing a foreign headquarters.
Administration Plan: The Administration Plan proposes tightening current law anti-inversion rules by reducing to 50% (from 80%) the so-called “continuity of interest” threshold and providing that “inverted” firms that continue to be managed and controlled from within the US would be treated as US-domiciled rather than foreign-domiciled.
The Administration Plan also states support for disallowing deductions for the offshoring of production although the specific proposal from the campaign that would have levied a 10% net profits tax on income derived from the production of goods or delivery of services abroad for sale or use in the US was not detailed.
SFC Plan: The SFC Plan did not address this issue.
Companies are advised to be evaluating and modeling the potential effects of both the Administration’s proposals and the options outlined in the SFC Plan. If you have any questions about the information in this True Alert, please contact a member of your TPC engagement team.