Authored by Jim Lawson, Christopher S. Brown and Kevin Kao
As explained in an earlier alert, Biden unveils infrastructure plan with corporate tax proposals, in spring 2021, the Biden administration released the “Made in America Tax Plan” which proposed changes to, among other things, the global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII) and base erosion and anti-abuse tax (BEAT) international tax rules. The following month, the Treasury Department released additional details about the administration’s tax reform proposals (including international tax reform) in a publication generally referred to as the “Green Book.”
On Aug. 25, 2021, Senate Finance Committee Chair Ron Wyden, D-Ore., and fellow panel Democrats released draft legislation and a summary of their international tax overhaul proposals (“Wyden Discussion Draft”). The Wyden Discussion Draft builds on the Made in America Tax Plan and requests public comments for consideration.
This Tax Alert describes a number of the potential international tax reform changes in the Wyden Discussion Draft that could have a substantial impact on taxpayers with overseas activities. It also compares and contrasts some of Wyden Discussion Draft’s proposed international tax changes to those contained in the Green Book and describes expected next steps for international tax reform in the coming days, weeks and months.
The international tax reform proposals in the Green Book and those in the Wyden Discussion Draft would both amend the GILTI rules such that they would apply on a “country-by-country” basis. That said, the proposals contain different approaches on how this would be applied. For example, in the Green Book a “U.S. Shareholder’s” (as defined in Section 951(b)) inclusion (referred to as a global minimum tax inclusion) would be determined separately for each foreign jurisdiction in which its controlled foreign corporations (CFCs) operate. As a result, a separate foreign tax credit limitation would also be required for each foreign jurisdiction.
Under the Wyden Discussion Draft, a country-by-country approach to GILTI (which would be renamed global inclusion of low-tax income) would apply through a mandatory high-tax exclusion mechanism that will functionally operate as a top-up tax. For example, if a U.S. Shareholder earns income in a foreign country that is subject to an effective tax rate above the GILTI rate, it would be excluded as high-tax income and generally would not be subject to residual U.S. tax until such time the underlying earnings are actually repatriated (and, even then, subject to a potential participation exemption under Section 245A for certain qualifying C corporation shareholders). Alternatively, if the U.S. Shareholder earns income in another foreign country that is subject to an effective tax rate below the GILTI rate, the income would be subject to a top-up tax that at least brings the total taxes on the income from that country up to the GILTI rate.
Determination of whether income is high-taxed will be modeled on the current GILTI high-tax exclusion regulations. Separately, the Wyden Discussion Draft notes that timing issues in the country-by-country high-tax exclusion proposal (e.g., losses in one year which may impact the tax on income in a succeeding year) are currently being considered.
There are some similarities to the two proposals with regard to GILTI reform in that both would prevent losses incurred in one country from being used to offset income in another. Additionally, both proposals would eliminate the 10% deemed return on QBAI owned abroad and would reduce the Section 250 deduction.
The Wyden Discussion Draft would also amend the current Subpart F income rules so they applied on a country-by-country basis vis-à-vis the high-tax exclusion approach. The GILTI and Subpart F income high-tax exclusions would both apply to “tested units” of a CFC, use the same aggregation rules and apply similar rules for losses. As such, the only substantial differences between the GILTI and the Subpart F high-tax exclusions would be: 1) the relevant type of income and 2) the tax rate.
The proposals in the Wyden Discussion Draft would also extend the high-tax exclusion rule to foreign branches on a country-by-country basis. However, since branch income is earned directly by a U.S. person (as opposed to through a CFC), it would operate with some differences from the high-tax exclusions for GILTI and Subpart F.
The Green Book mentions that a similar jurisdiction-by-jurisdiction approach would apply to U.S. taxpayers’ foreign branch income. However, the Green Book proposal would repeal the high-tax exclusion for GILTI and the high-tax exception to Subpart F.
Under the current foreign tax credit rules, foreign taxes attributable to GILTI income are reduced by a 20% “haircut.” The Wyden Discussion Draft provides that, to the extent there is a foreign tax credit haircut for GILTI income, there would also be a similar foreign tax credit haircut for Subpart F, withholding taxes on previously taxed earnings and profits and foreign branch income. The Wyden Discussion Draft also provides that the rate of the haircut could range from 0% to 20% and could be different depending on whether it applies to GILTI, Subpart F or foreign branch income.
The definition of deemed intangible income in the current FDII rules would be replaced with “domestic innovation income.” Domestic innovation income in the Wyden Discussion Draft would be an amount equal to the sum of an unspecified percent of qualified research and development expenditures plus an unspecified percent of qualified worker training expenses from domestic activities. In the Green Book, the FDII deduction would be repealed and potentially replaced by an unspecified research and development incentive.
In the Wyden Discussion Draft, the BEAT would be amended to incorporate the purposes and policies of the SHIELD proposal put forth by the Biden administration in the Green Book. This, presumably, would bring the BEAT regime more in line with the Organization for Economic Cooperation and Development’s Base Erosion and Profit Shifting Pillar 2 “global minimum tax” framework. Additionally, however, the proposal would also restore tax credits for domestic investment.
The Green Book provides that the BEAT would be repealed and replaced with the SHIELD. Additionally, in the Green Book, the SHIELD would disallow deductions to domestic corporations or branches by reference to low-taxed income of entities that are members of the same financial reporting group.
The Wyden Discussion Draft would amend the foreign tax credit limitation rules for certain expenses incurred in relation to domestic activities. Specifically, expenses for research and experimentation and for “stewardship” would be treated as 100% allocated to U.S. source income for purposes of determining the foreign tax credit limitation if those activities are conducted in the U.S. Expenses for these activities performed outside the U.S. would continue to be allocated and apportioned as they are under current law.
Draft budget legislation (informally known as the “chairman’s mark”) with reconciliation bill instructions is expected to be released shortly with a view to be voted on in late September. As such, we are expecting draft bill legislation to be released in the coming days or weeks. We will provide further updates as draft legislation is issued.
We encourage you to connect with your Baker Tilly advisor regarding how any of the above may affect your tax situation.
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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.