Green Book release offers insight into international tax proposals

The Green Book details the need to increase revenue from outbound investments by adjusting tax rates on income derived from foreign jurisdictions by US multinational organizations, repealing current tax incentives for holding tangible assets overseas, and denying deductions for related-party payments that potentially erode the US tax base. The proposals are a substantial departure from the Base Erosion and Anti-Abuse Tax (“BEAT”), Foreign Derived Intangible Income (“FDII”) and Global Intangible Low-Taxed Income (“GILTI”) regimes as they were enacted in the 2017 Tax Cuts and Jobs Act.

The Green Book indicates that the majority of the proposals would be effective for tax years beginning after December 31, 2021.

Repealed

The Green Book describes the repeal of the FDII deduction and its replacement with tax-based incentives for research and development (“R&D”) in the United States. Currently, the FDII regime is an export incentive for US corporations that provides a deduction for property sold, or services provided, for foreign use by the taxpayer.

In lieu of FDII, the Administration proposed a new 10% general business credit for qualified expenses related to onshoring to the US a trade or business that is currently conducted overseas with the purpose of creating jobs in the US.

With respect to the BEAT, this regime would be replaced with a new regime called SHIELD that would simply deny deductions for payments tied to base erosion. Currently, BEAT penalizes base erosion payments when such payments exceed 3% of the total deductible payments made by taxpayers that are part of multinational affiliated groups with average annual gross receipts of at least $500 million. For BEAT purposes, base erosion payments are generally deductible related-party payments.

With this regulatory development, taxpayers that make related-party payments that potentially erode the US tax base would not be subject to the punitive alternate tax. Instead, deductions derived from these transactions would be denied for all gross payments that are made (or deemed made) to foreign related parties whose income is subject to a low effective rate of tax (ETR) in the local jurisdiction.

The repeal of the FDII and BEAT regimes is being painted as a significant revenue raiser, representing more than $500 billion over 10 years. Despite FDII coming under increasing criticism, particularly from abroad, the Wyden/Brown/Warner plan instead proposes to modify rather than repeal FDII.

Modified

The regime introduced by the TCJA to impose current tax on active income derived from foreign jurisdictions to avoid tax deferring is called GILTI. Under current law, this regime offers a 50% deduction on the effective tax rate (taxed at a rate of 10.5%) to US corporate shareholders, producing an incentive to derive foreign-sourced income instead of income within the US, generally taxed at a rate of 21%.

Additionally, taxpayers are able to exclude a deemed return on tangible assets used in a foreign trade or business from the GILTI computation. Accordingly, 10% of the qualified business asset investment (similar to adjusted basis of depreciable tangible property) is excluded from the GILTI computation and reduces a taxpayer’s foreign income subject to GILTI.

The Biden Administration’s proposal to amend GILTI seems to stem from a desire to close perceived loopholes in the regime. Proposed changes include rules with the stated intention of addressing three relevant policy issues: i) Preference to earn income overseas, ii) Foreign tax credit blending, and iii) Incentive for companies to locate tangible investment offshore.

First, the preference to earn foreign-derived income would be mitigated by increasing the GILTI effective tax rate. One of the major changes that the Biden Administration has announced is the increase in the corporate tax rate from 21% to 28%. Accordingly, the Green Book describes the proposal to grant a 25% deduction (instead of 50%) taking into account the new corporate tax rate. As a result, taxpayers with GILTI inclusions would be taxed at an effective rate of 21% on the foreign income.

As a second measure, the proposal provides for US shareholders to determine their GILTI inclusion and foreign tax credit (“FTC”) limitation on a country-by-country basis, thus preventing foreign tax credit blending where high-tax jurisdictions deemed taxes are credited against GILTI inclusions from low-tax jurisdictions. Additionally, the proposed amendments would repeal the high tax exception for both GILTI and subpart F.

In connection with the issue of incentivizing companies to locate tangible investment abroad, the proposal would eliminate the tax-free deemed return on tangible assets by computing GILTI inclusion without regard to the 10% of QBAI exclusion.

The Green Book also describes a new limitation on interest deductions that apply to members of a multinational group that prepare consolidated financial statements in accordance with US GAAP or IFRS. The change would mean that a member’s interest deduction would be limited when the member’s proportionate share of the financial reporting group’s net interest expense reported on the group’s consolidated financial statements is lower than the member’s net interest expense for financial reporting purposes.

The repeal of Section 904(b)(4), a provision that impacts the treatment of deductions allocated to income exempt under Section 245A for purposes of foreign tax credit limitation, is proposed. In lieu of Section 904(b)(4), an expansion of Section 265 is proposed which would disallow the allocation of deductions to income exempt from US tax (e.g. Section 245A) or subject to a preferential rate (e.g. Section 250).

Mazars’ Insight

The proposals to modify GILTI are unfavorable across the board, but the repeal of QBAI may hit certain industries the hardest. Also notable is the lack of a proposal to remove the 20% haircut on GILTI FTCs.

Also included in the budget is a proposal for a technical change to limit foreign tax credit benefits associated with the sale of a hybrid entity or a check-the-box election.

Section 338(h)(16) operates to deny a foreign tax credit benefit that might otherwise be available from the recharacterization of gain on the sale of stock as a sale of assets if a section 338 election is made. Because of the application of section 338(h)(16), the deemed asset sale resulting from a section 338 election is not treated as occurring for purposes of determining the source or character of any item when applying the foreign tax credit rules to the seller. Instead, for these purposes, the gain is generally treated by the seller as gain from the sale of the stock.

The proposal would extend the principles of section 338(h)(16) to sales of hybrid entities or check-the-box elections, to determine the source and character of any item recognized in connection with a direct or indirect disposition of an interest in a specified hybrid entity and to a change in entity classification of an entity not recognized for foreign tax purposes (for example, due to an election under the entity classification regulations).

For purposes of applying the foreign tax credit rules, the source and character of any such item would be determined based on the source and character of an item of gain or loss the seller would have taken into account on the sale or exchange of stock (determined without regard to section 1248). Because the proposal is limited to determining the source and character of such an item of gain or loss for purposes of applying the foreign tax credit rules, it does not affect the amount of gain or loss recognized as a result of the transaction.

Mazars’ Insight

The proposed rule change has a small score in the revenue estimations of less than $500 million over 10 years. A similar proposal was included in the Obama 2016 budget.

Finally, the proposals would expand the scope of acquisitions covered by the inversion rules completed after the date of enactment, including distributions of foreign corporation stock by domestic corporations or partnerships. For purposes of treating a foreign acquiring corporation as a US company, the new provision would decrease the current 80% threshold of continuing ownership to 50%.

New regimes

As mentioned above, the Biden Administration proposes to repeal BEAT and replace it with SHIELD. This brand-new regime would deny deductions by reference to all gross payments that are made (or deemed made) to low taxed members. Interestingly, the threshold to determine whether a member is a “low taxed member” would be based on the rate agreed to under Pillar Two of the OECD’s BEPS initiative. However, it would be determined by reference to the 21% GILTI rate until global minimum tax rates are adopted.

As a result, deductible payments made by domestic corporations directly to low taxed members would be subject to the SHIELD rule in their entirety in the context of financial reporting groups with greater than $500 million in annual global revenues.

In order to increase revenue, the Biden Administration would also introduce a minimum book tax on qualified multinational corporations discussed in detail in Mazars’ Tax Alert, “2022 Green Book: Corporate Tax Proposals.”

Please contact your Mazars professional for additional information.

Published on June 10, 2021

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.