Reuven S. Avi-Yonah is the Irwin I. Cohn Professor of Law at the University of Michigan Law School in Ann Arbor. Gianluca Mazzoni received his SJD in international tax in 2020 from the University of Michigan Law School. Email: aviyonah@umich.edu, gmazzoni@umich.edu
In this article, the authors review the tax plan of Democratic presidential candidate Joe Biden and vice presidential candidate Kamala Harris, focusing on proposed changes to the U.S. international tax system.
Copyright 2020 Reuven S. Avi-Yonah and Gianluca Mazzoni. All rights reserved.
The October 7 U.S. vice presidential debate highlighted fundamental differences between the two parties’ approaches to the economy and tax policy. In particular, vice presidential candidate Sen. Kamala D. Harris, D-Calif., criticized the Tax Cuts and Jobs Act for “benefitting the top 1 percent and the biggest corporations of America, leading to a $2 trillion deficit that American people are going to have to pay for.” She also said, “The economy is about investing in the people of our country, as opposed to passing a tax bill, which had the benefit of letting American corporations go offshore to do their business.”
This article briefly discusses the tax plan recently released by Democratic presidential candidate Joe Biden,1 with a focus on the proposed changes to the U.S. international tax system.
GILTI Changes
Current law imposes a minimum rate of 10.5 percent on the global intangible low-taxed income of U.S. shareholders of controlled foreign corporations, with a deduction of 37.5 percent (21.875 percent for tax years beginning after 2025) for foreign-derived intangible income plus 50 percent (37.5 percent for tax years beginning after 2025) of GILTI. Generally, GILTI is a U.S. shareholder’s aggregate CFC income in excess of a deemed 10 percent return on a CFC’s qualified business asset investment. QBAI is the adjusted basis of tangible assets used in a trade or business.
The GILTI rules were intended to reduce potential advantages from operating in low-tax jurisdictions but created an unexpected incentive for U.S. multinationals to increase the amount of tangible assets held by their CFCs offshore.
Indeed, increasing QBAI held by CFCs is one of the most effective ways to manage or reduce GILTI. For example, take Whirlpool, which manufactures and distributes major household appliances in the United States and abroad. The more money Whirlpool spends on land, buildings, and equipment overseas, the more it increases its QBAI deduction on its GILTI.2 As such, on December 31, 2019, Whirlpool recognized an immaterial provision for GILTI and elected to treat the tax effect of GILTI as a current-period expense.
In June the U.S. Treasury Department issued final regulations (T.D. 9866) to eliminate transitory QBAI movements and transfers undertaken primarily to increase the deemed tangible income return on QBAI. Yet the new rebuttable presumption in reg. section 1.951A-3(h)(1)(iv)(A) left opportunities to mitigate GILTI and expanded the possibilities for tax-efficient QBAI increases through the transfer of qualifying tangible assets, or stuffing, and tested income decreases through transfers and washing, possibly below the 10 percent threshold.3
For those reasons, Biden has said he wants to minimize the GILTI-reducing benefits of offshore investment by doubling the tax rate on GILTI from 10.5 percent to 21 percent and eliminating the exemption for QBAI. Further, he would compute the GILTI tax (and related foreign tax credits) country by country, rather than use a worldwide average.4
It has already been argued that current legislation encourages U.S. multinationals to locate investment in low-tax jurisdictions and blend that income with income from high-tax jurisdictions.5 For example, take a U.S. multinational earning $1 million of income in Country A, taxed at a local rate of 21 percent.6 The multinational is deciding whether an additional $2 million in profits (and any associated activity) should be located in either the United States or a low-tax jurisdiction. There would be tax of $210,000 in A and a tentative GILTI tax of $105,000 ($1 million * 0.105). The U.S. multinational, however, is entitled to an FTC for 80 percent of its CFC’s foreign taxes attributable to GILTI, reducing the GILTI tax to zero. That would leave $63,000 of excess FTCs ($105,000 - ($210,000 * 0.8)) that are lost forever because the rules do not provide for any carryovers or carrybacks of excess credits for GILTI taxes. If an additional $2 million in profits were earned in the United States, the total tax liability would be $630,000 ($210,000 + $420,000). If the additional profits were instead earned in a low-tax jurisdiction with a local rate of 0 percent, the total tax liability would be $357,000 ($210,000 + $147,000) as opposed to $420,000 under a per-country GILTI approach.
Biden’s proposed GILTI changes are similar to the tax proposals in President Obama’s 2016 budget, which included a 19 percent minimum tax on the foreign earnings of CFCs or foreign branches or from the performance of services abroad.7 Unlike Obama’s minimum tax proposal or Option C of Dave Camp’s Tax Reform Act of 2014, a return on foreign assets would not be exempt under the Biden-Harris tax plan.
It is also possible that S. 1610, the Removing Incentives for Outsourcing Act, introduced in May 2019 by Sen. Amy Klobuchar, D-Minn., inspired the conceptual underpinnings of Biden’s proposed GILTI changes. S. 1610 would modify the GILTI regime by repealing the tax-free deemed return on investments and determining net CFC tested income on a per-country basis. In particular, the bill would institute a per-country minimum tax, instead of a blended or global rate, and eliminate companies’ ability to deduct 10 percent of their return on tangible assets before the tax rate on foreign income applies. According to Klobuchar, those changes would remove the incentive for U.S. multinationals to shift U.S. jobs and physical operations overseas. The bill would also require the Joint Committee on Taxation to study various proposals for taxing income from international sources and evaluate them based on whether they minimize opportunities for tax avoidance and incentives for domestic businesses to move jobs and operations to other countries.
Other Anti-Offshoring Policies
Biden and Harris would also establish a 28 percent corporate tax rate plus a 10 percent offshoring penalty surtax on profits of any production by a U.S. company overseas for sales back to the United States. The surtax would also apply to call centers or services by a U.S. company located overseas but serving the United States if the jobs could have been located in the United States. It would likely be implemented as an expansion of the subpart F regime and thus would only apply to U.S.-parented multinationals.
It is possible that the Biden-Harris tax plan was inspired by 2017 proposals such as H.R. 2005 by Rep. David N. Cicilline, D-R.I., and S. 863 by Sen. Sheldon Whitehouse, D-R.I.8 For example, H.R. 2005 would amend IRC section 954 by adding section (j) on imported property income, defined as income (whether profits, commissions, fees, or otherwise) derived in connection with manufacturing, producing, growing, or extracting imported property; the sale, exchange, or other disposition of that property; or the lease, rental, or licensing of imported property. Imported property is defined as property imported into the United States by the CFC or a related person. It also includes any property imported into the United States by an unrelated person if, when the CFC (or a related person) sold it to the unrelated person, it was reasonable to expect that the property would be imported into the United States or used as a component in other property that would be imported into the United States. Section 954(j)(2)(C) would provide an exception for property subsequently exported by excluding any property imported into the United States if, before substantial use in the United States, it is sold, leased, or rented by the CFC or a related person for direct use, consumption, or disposition outside the United States or is used by the CFC or a related person as a component in other property that is sold, leased, or rented (some agricultural commodities are also excluded). Section 954(j)(3)(D) would provide coordination with the foreign base company sales income rules by excluding imported property income from foreign base company sales income.
If Biden is elected and the Democrats keep control of the House and take over the Senate, we expect that the offshoring penalty surtax will be drafted along the lines of the Cicilline and Whitehouse proposals.
The Biden-Harris tax plan would also deny all deductions and expensing write-offs for offshoring jobs or production that could plausibly have been offered to U.S. workers or done in the United States. The plan provides for some sort of carrot, such as a “made in America” tax credit to reward those who invest in and create U.S. jobs. The 10 percent credit would be available for companies that revitalize closed or closing facilities; retool any facility to advance manufacturing competitiveness and employment; bring job-creating production back to the United States; expand or broaden U.S. facilities to grow U.S. employment; and expand manufacturing payroll. The credit will be advanceable, meaning taxpayers can claim it immediately on incurring an eligible expense without waiting to file their annual income tax returns to receive it.
Finally, Biden would also implement strong anti-inversion regulations and penalties.9
Conclusion
The Biden-Harris tax plan does not suggest anything new or reinvent the wheel in its proposed changes to the U.S. international tax system. Yet it should be recognized that the plan would try to make the U.S. international tax system fairer and more coherent by closing some of the TCJA’s loopholes.
GILTI is not protecting the U.S. tax base by capturing high-return income to prevent outsourcing, and the United States could lose jobs and revenue because of QBAI and a focus on intangible assets. The next U.S. president should fix those problems.
FOOTNOTES
1 All references to the Biden-Harris tax plan are to the 11-page fact sheet released September 9.
2 For example, Whirlpool may increase its tangible investment overseas on qualified business assets (machinery, equipment, inventories, and so forth) and expand its overseas factories, such as the Ramos and Horizon plants owned by Industrias Acros Whirlpool SA de CV, one of its Mexican subsidiaries. Recently, the U.S. Tax Court found that Whirlpool’s income earned through its Mexican branch is foreign base company sales income. For a comment on that case, see Gianluca Mazzoni, “Watch Out Whirlpool: The IRS Has Put 50 Million Wrinkles in Your Permanent Press Cycle” (forthcoming 2020).
3 Benjamin M. Willis, “GILTI’s No-Limit Standard Deduction,” Tax Notes Federal, Oct. 5, 2020, p. 85. In that regard, the per se antiabuse rule included in the proposed regulations was certainly overbroad but definitely better than the final rebuttable presumption. See the preamble to the final GILTI regs.
4 Supra note 1. For the reasons why Congress allowed taxpayers to average low-tax income with higher-tax income for computing the foreign tax credit, see George Callas and Mark Prater, “Is GILTI Operating as Congress Intended?” Tax Notes Int’l, Jan. 6, 2020, p. 89. For whether a minimum tax on foreign income — or a worldwide income tax with limited FTCs — should be calculated on an overall or per-country basis, see Martin A. Sullivan, “Fixing GILTI, Part 4: Overall or Per-Country Limitation,” Tax Notes Int’l, June 17, 2019, p. 1170.
5 See David Kamin et al., “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the 2017 Tax Legislation,” 103(3) Minn. L. Rev. 1439, at 1490 (Feb. 2019).
6 Id. at 1491-1492.
7 The Obama administration proposed a per-country minimum tax. The tentative minimum tax base would have been reduced by an allowance for corporate equity, providing a risk-free return on equity invested in active assets. It was thus intending to exempt from the minimum tax a return on the actual activities undertaken in a foreign country.
8 Whitehouse and Cicilline introduced similar bills in 2011 and 2015, respectively.
9 Under section 7874, if a domestic corporation’s shareholders own at least 80 percent of the new foreign parent corporation’s stock after the inversion transaction (whether by stock or asset transfer, or any combination of the two), the new foreign parent is treated as a domestic corporation for all federal tax purposes for 10 years.
END FOOTNOTES