By Alex M. Parker, Director, Capitol Counsel LLC, Washington, DC
The most recent version of the Democrats’ plan to overhaul the U.S. tax code – approved by the House Ways and Means Committee on September 15 – suggests the party may back down on its promise to repeal a key part of the law international conference on tax cuts and jobs. framework. The law’s tax exemption for foreign tangible property is secure, for now, in part due to global pressure and concerns about US competitiveness.
During the 2020 campaign, amid an environment of angry populism and ‘America First’ rhetoric, then-candidate Joe Biden blamed the exemption, which is part of the global intangible income tax. low tax, loss of American jobs. It was a “tax loophole that actually rewards companies for shipping jobs and profits overseas,” Biden said.
He echoed criticisms Democrats had voiced even before the law was passed – that by granting favorable tax treatment to tangible goods abroad, the law diverted the rules of the game from domestic manufacturing and production. and towards foreign investments.
And yet, the tangible property exemption at GILTI looks set to survive. Its sustainability is due in part to the interaction between Congress and the G20 international tax negotiations, but it also reflects the new direction of global and interconnected tax policy for years to come.
One of the main goals of the TCJA was to move the United States to a territorial tax system that exempted most foreign income from tax. But to prevent companies from siphoning their profits out of the United States, the law also called for a 10.5% tax on foreign income, which is only half the overall rate of 21%. The provision, known as the Global Low Tax Intangible Income Tax or GILTI, applies to returns of 10% or more on depreciable property held abroad. The authors of the bill believed that the unusually high profits from tangible assets should be intangible – derived from assets such as patents or copyrights, which are often used in complex tax structures due to their mobility and of their high value.
Democrats were quick to note that a company would have less GILTI liability plus the tangible assets it held overseas, as long as its foreign income remained the same. If that tangible asset – what the law calls qualified business investment or QBAI – is a facility, it can be tied to jobs. This quickly became a central criticism of the bill, which critics say contributed to job losses in the United States, such as General Motors Co.’s shutdown of its Lordstown, Ohio auto plant.
Despite Democratic criticism, the GILTI concept proved intriguing to the rest of the world, especially since it dealt with complaints about global tax evasion. The Organization for Economic Co-operation and Development, a global body that sets international tax standards, has included a similar proposal in a package of proposed reforms to address concerns about taxation in the digital economy, requested by the G20 coalition. in 2017. In 2020, the new Biden administration promoted the concept as a comprehensive minimum tax agreement.
True to its stance on GILTI, the Biden administration pushed the OECD to adopt a true minimum tax targeting all income. The aim was not only to stop artificial profit transfers, but also to end what US Treasury Secretary Janet Yellen called the “race to the bottom” between countries trying to attract real money. investments with increasingly lower tax rates.
The same debate as in the United States has taken place in international debates. But the OECD ultimately opted for a “formal substance-based exclusion,” which officials said was the only way to ensure all countries approved the deal. The exclusion is potentially even larger than QBAI, including payroll as well as tangible assets in the calculation.
The OECD decision made repealing a QBAI a much more difficult proposition – especially given assurances from Yellen and the administration that a global minimum tax deal would allow the United States to increase their corporate tax rate without risking economic competitiveness. Without an exemption for physical properties, the U.S. global minimum tax would be larger and more onerous than similar taxes imposed elsewhere, increasing the prospects for corporate reversals or foreign takeovers.
In light of this dynamic, it’s no surprise that House Democrats have hesitated and opted for a plan that retains QBAI, despite reducing the exemption to 5% of foreign depreciable property from a business, instead of 10%. Their version of the legislation, which was passed by the House Budget Committee on September 25 and is expected to be presented to the House later this week, is not necessarily what Congress will ultimately consider. One version of the Senate completely eliminates the QBAI exemption. But the House plan probably reflects the language with the most consensus among Democrats.
It might seem like a minor adjustment. But the change reflects the current direction of global tax policy. Despite American proclamations, the rest of the world is not ready to give up tax competition. Instead, countries are prepared to accept only a targeted minimum tax on intangible income involved in outright tax evasion. America’s broader vision of harmonizing all corporate tax rates will have to wait, for now, as countries retain the freedom to tax actual activities at the rate that suits them best. Ireland has already said it is considering double rates to keep its 12.5% corporate tax rate for domestic businesses, taking advantage of the OECD’s substantive exemption.
And while the Democrats have pledged to equalize foreign and domestic tax rates and tax the profits of American businesses wherever they are, their equal commitment to multilateralism has blocked their desire to pursue full global taxation. In the United States, home to a large percentage of the world’s richest businesses, global residence-based taxation can be an easy political sell-off. But the rest of the world remains reluctant to use residence, a sometimes delicate and arbitrary concept, as the basis of the tax system.
While Democrats are on the verge of giving up hope of repealing QBAI, they are still pursuing other measures to tighten GILTI’s reach. The House’s proposal would calculate the amount of GILTI country by country, rather than aggregating all foreign income as under current law. Democrats say the mix allows companies to continue using tax havens, as long as they mix them with higher tax countries.
But Democrats’ legislation would also allow companies to carry forward excess foreign tax credits as well as losses for GILTI. The result would be a system that is both more focused and flexible and in line with the OECD design. According to a first estimate by the Joint Commission on Taxation, the changes to the GILTI regime, as well as the deduction on intangible income from foreign sources or FDII, its domestic counterpart, will make it possible to raise a little more than $ 200 billion for the ten coming years. That’s no small number, but it does make it a relatively small part of the $ 3.5 trillion infrastructure package, seemingly out of proportion to Democrats’ rhetorical emphasis on alleged corporate tax avoidance.
When it comes to offshoring, the scant data academics have collected in the three years since the adoption of the TCJA makes it difficult to determine whether QBAI actually contributes to foreign investment. Defenders of the law note that other factors are likely to override tax considerations when companies make location decisions. And a country with a corporate tax rate low enough to make a difference may not have the infrastructure or the workforce to make an investment profitable.
That’s the essence of territorial tax philosophy – making sure the rules for measuring taxable income are fair, then ditching the tokens where they can. While the United States may not yet be fully on board, the rest of the world is ready to take the gamble.