Reuven S. Avi-Yonah is the Irwin I. Cohn Professor of Law at the University of Michigan. He thanks Jeffery M. Kadet and Stephen E. Shay for their helpful comments.
In this article, Avi-Yonah considers the Biden administration’s Made in America Tax Plan, which would overhaul the corporate and international tax provisions of the Tax Cuts and Jobs Act and represents a long-overdue effort to more fairly tax U.S.-based multinationals.
Copyright 2021 Reuven S. Avi-Yonah.
All rights reserved.
On March 31 the White House released an outline of its proposed infrastructure bill, which includes the Made in America Tax Plan.1 The plan involves a major revamping of the corporate and international tax provisions in the Tax Cuts and Jobs Act, including:
raising the corporate tax rate from 21 percent to 28 percent;
eliminating the participation exemption for a 10 percent return on qualified business asset investment;
reforming the global intangible low-taxed income regime by raising the rate to 21 percent and applying it per country;
strengthening the anti-inversion rules;
replacing the base erosion and antiabuse tax with a stronger but conditional denial of deductions to related foreign parties; and
repealing the foreign-derived intangible income regime and replacing it with increased research and development subsidies for domestic activities.
The plan is a long-overdue recognition that U.S.-based multinationals have not been paying their fair share of taxes, given their levels of profitability, most of which are economic rents not subject to competition because of their monopolistic or oligopolistic positions in their respective markets. Also, the BEAT replacement will be a major incentive for other countries to enact similar legislation under the auspices of pillar 2 of the OECD’s base erosion and profit-shifting initiative due to be completed by June.
The Corporate Rate
The Biden plan would raise the corporate rate from 21 percent to 28 percent, an overdue recognition that the lower rate is inappropriate when 91 Fortune 500 companies paid $0 in federal corporate taxes on U.S. income in 2018.2 In fact, according to recent analysis by the Joint Committee on Taxation, the TCJA cut the average rate that corporations paid from 16 percent to less than 8 percent in 2018.3
Moreover, numerous economic studies have shown that the corporate tax falls primarily on economic rents and capital.4 Moreover, 70 percent of corporate equities are held by foreigners or tax-exempt entities, so the corporate tax is often the only level of tax imposed on capital (even for taxable shareholders, the shareholder tax is deferred until a dividend is paid or the shares are sold).5 Moreover, two-thirds of the profits shifted into tax havens by multinationals have been shifted out of the United States.6
I have argued elsewhere that those facts justify much higher levels of corporate taxation on a progressive basis, but 28 percent is a good start.7 Biden’s proposal will return corporate tax revenue as a share of the economy to around its 21st-century average before the TCJA, which is still well below where it stood before the 1980s.
Eliminating QBAI
The Biden plan eliminates the TCJA’s exemption for dividends from controlled foreign corporations for a 10 percent return on tangible investment overseas (QBAI). Given the competitive advantage of U.S. multinationals and the incentive the TCJA provision creates for offshoring investment and jobs, this is an essential reform. It also revives the rule that U.S. corporations should be taxed on all income “from whatever source derived,” which was in place from 1909 to 2017.8 That encourages investment in the United States and lessens — but does not eliminate — the advantage multinationals have over purely domestic companies.
Reforming GILTI
The Biden plan retains GILTI and raises its rate to 21 percent on a per-country basis. Now, most U.S. multinationals are in an excess credit position (because the current U.S. tax rate is well below the OECD average), so this is an essential reform that reduces the incentive to invest in low-tax foreign jurisdictions and average the income from them with high-taxed income elsewhere, resulting in additional profit shifting and no residual U.S. tax.
I would have preferred to set the GILTI rate at 28 percent, given that any difference between domestic and foreign rates creates an incentive to shift profits out of the United States, leads to transfer pricing disputes, and gives multinationals a competitive advantage over domestic U.S. corporations. But President Biden campaigned on the 28-21 percent rate structure, so that is the best that can be achieved politically now. Twenty-one percent is below the OECD average, and the BEAT replacement discussed below will pressure U.S. trading partners to adopt a similar minimum tax under the auspices of BEPS pillar 2.
Anti-Inversion Rules
Because GILTI applies only to U.S. multinationals, it is important to strengthen the anti-inversion rules to prevent their avoiding GILTI by inverting. The Biden plan does not give details, but it is likely to be based on Obama administration proposals that envisaged lowering the section 7874 threshold from 80 percent to 50 percent for a foreign corporation to be treated as domestic, as well as adopting a managed and controlled standard for corporate residency. The first provision means that only true mergers between U.S. targets and larger foreign acquirers will escape being treated as inversions. By defining corporate residency under a managed and controlled standard, the second provision eliminates the biggest reason why only the United States and none of its trading partners underwent a wave of inversions before 2017.9
Replacing BEAT
Probably the most important, as well as the most innovative, proposal in the Biden plan is the repeal and replacement of BEAT. It would:
encourage other countries to adopt strong minimum taxes on corporations, just like the United States, so that foreign corporations aren’t advantaged and foreign countries can’t try to get a competitive edge by serving as tax havens. This plan also denies deductions to foreign corporations on payments that could allow them to strip profits out of the United States if they are based in a country that does not adopt a strong minimum tax. It further replaces an ineffective provision in the 2017 tax law that tried to stop foreign corporations from stripping profits out of the United States. The United States is now seeking a global agreement on a strong minimum tax through multilateral negotiations. This provision makes our commitment to a global minimum tax clear. The time has come to level the playing field and no longer allow countries to gain a competitive edge by slashing corporate tax rates.
The idea is that instead of the ineffective BEAT, which raises minimal revenue because it can easily be avoided, there will be a broad denial of deductions (including, crucially, cost of goods sold, because its absence is the biggest loophole in BEAT) for payments to related foreign corporations that are not resident in countries with a minimum tax similar to the revised GILTI (ideally, 21 percent or higher).10 That will place strong pressure on major U.S. trading partners to adopt those kinds of minimum taxes as part of the OECD BEPS pillar 2 negotiations.
I have long argued that the best way to address concerns about competitiveness (however misguided) is to cooperate with major U.S. trading partners in setting minimum corporate rates. More than 90 percent of multinationals are headquartered in the G-20, which is the driving force behind pillar 2. If only the G-20 adopted strong minimum taxes, the whole competitiveness issue is eliminated, and all the neutralities are achieved simultaneously. The Biden proposal goes a long way toward achieving that goal.11
Repealing FDII
The Biden plan will reform the way R&D is promoted. That starts with eliminating the TCJA tax incentives for FDII, which gave corporations a tax break for shifting assets abroad and fails to encourage corporations to invest in R&D. All the revenue from repealing the FDII deduction will be used to expand “more effective R&D investment incentives.”
FDII is an unjustified subsidy for U.S. exporters that benefits some of the largest U.S. multinationals over domestic corporations, does not promote domestic R&D, and has not increased foreign direct investment into the United States.12 Moreover, it is a violation of the WTO rules and therefore could create trade sanctions.13
The proposal to replace FDII with R&D incentives is unclear, but it may refer to repealing the TCJA’s limit on R&D expensing, due to begin in 2022. R&D expensing is a major reason why U.S. multinationals often pay zero tax, together with the deduction for stock options when exercised rather than when granted. I would have preferred a FDII replacement that is more targeted to creating jobs in struggling U.S. areas.14 But at least the Biden plan also includes a 15 percent tax on the book income of large corporations, so neither increased R&D deductions nor stock options can wholly eliminate tax liability.
Conclusion
The Biden plan is a major step forward in reforming U.S. corporate and international rules to prevent U.S. multinationals from having a competitive advantage over domestic U.S. corporations, as well as a long-overdue stride toward making them pay a fair share of taxes. Given that the resulting revenue will help pay for essential investment in America’s future, the plan should be enacted as soon as possible. We should all hope that the Democrats in Congress can unite in passing it through reconciliation.
FOOTNOTES
1 See Andrew Velarde and Stephanie Soong Johnston, “Biden Proposes Eliminating FDII, Changing Earnings-Stripping Law,” Tax Notes Federal, Apr. 5, 2021, p. 101.
2 Institute on Taxation and Economic Policy, “Corporate Tax Avoidance in the First Year of the Trump Tax Law” (2019).
3 See Avi-Yonah, “Hanging Together: A Multilateral Approach to Taxing Multinationals,” in Global Tax Fairness 113 (2016); Avi-Yonah and Haiyan Xu, “Evaluating BEPS: A Reconsideration of the Benefits Principle and Proposal for UN Oversight,” 6 Harv. Bus. L. Rev. 185 (2016); Avi-Yonah and Nicola Sartori, “International Taxation and Competitiveness: Introduction and Overview,” 65 Tax L. Rev. 313 (2012); Avi-Yonah and Gianluca Mazzoni, “BEPS, ATAP and the New Tax Dialogue: A Transatlantic Competition?” 46 Intertax 885 (2018); and Avi-Yonah, “Tax Competition and Multinational Competitiveness: The New Balance of Subpart F,” Tax Notes Int’l, Apr. 19, 1999, p. 1575.
4 See Kimberly A. Clausing, “Who Pays the Corporate Tax in a Global Economy?” 66 Nat’l Tax J. 151 (2013); Clausing, “In Search of Corporate Tax Incidence,” 65 Tax L. Rev. 433 (2012); Edward Fox, “Does Capital Bear the U.S. Corporate Tax After All? New Evidence From Corporate Tax Returns,” 17(1) J. Empirical Legal Stud. 71-115 (2020); Fox and Zachary Liscow, “A Case for Higher Corporate Tax Rates,” Tax Notes Federal, June 22, 2020, p. 2021; Laura Power and Austin Frerick, “Have Excess Returns to Corporations Been Increasing Over Time?” 69 Nat’l Tax J. 831 (2016); and Benjamin H. Harris, “Corporate Tax Incidence and Its Implications for Progressivity,” Urban-Brookings Tax Policy Center (Nov. 2009).
5 Leonard E. Burman, Clausing, and Lydia Austin, “Is U.S. Corporate Income Double-Taxed?” 70 Nat’l Tax J. 675 (2017).
6 Clausing, “Profit Shifting Before and After the Tax Cuts and Jobs Act,” 73 Nat’l Tax J. 1233 (2020).
7 Reuven S. Avi-Yonah, “A New Corporate Tax,” Tax Notes Federal, July 27, 2020, p. 653.
8 See Avi-Yonah, “Back to 1913? The Ryan-Brady Blueprint and Its Problems,” Tax Notes, Dec. 12, 2016, p. 1367.
9 See Avi-Yonah, “Beyond Territoriality and Deferral: The Promise of ‘Managed and Controlled,’” Tax Notes Int’l, Aug. 29, 2011, p. 667.
10 Because the reformed BEAT will not apply to foreign corporations subject to a minimum tax, it will not apply to CFCs subject to GILTI, which will also eliminate the problem of not granting foreign tax credits against BEAT liability. Because a provision that applies only to foreign related parties is a violation of the nondiscrimination article of U.S. tax treaties, it is important to explicitly make it a treaty override.
11 See Avi-Yonah, “Hanging Together: A Multilateral Approach to Taxing Multinationals,” in Global Tax Fairness 113 (2016); Avi-Yonah and Haiyan Xu, “Evaluating BEPS: A Reconsideration of the Benefits Principle and Proposal for UN Oversight,” 6 Harv. Bus. L. Rev. 185 (2016); Avi-Yonah and Nicola Sartori, “International Taxation and Competitiveness: Introduction and Overview,” 65 Tax L. Rev. 313 (2012); Avi-Yonah and Gianluca Mazzoni, “BEPS, ATAP and the New Tax Dialogue: A Transatlantic Competition?” 46 Intertax 885 (2018); and Avi-Yonah, “Tax Competition and Multinational Competitiveness: The New Balance of Subpart F,” Tax Notes Int’l, Apr. 19, 1999, p. 1575.
12 See Avi-Yonah, “The Baby and the Bathwater: Reflections on the TCJA’s International Provisions,” Tax Notes Federal, Feb. 1, 2021, p. 765.
13 Avi-Yonah, “Does the United States Still Care About Complying With Its WTO Obligations?” 9 Colum. J. Tax L. Tax Matters 12 (2018); and Avi-Yonah and Martin Vallespinos, “The Elephant Always Forgets: US Tax Reform and the WTO,” University of Michigan Law and Economic Research Paper No. 18-006 (Jan. 28, 2018).
14 See Avi-Yonah et al., “Federalizing Tax Justice,” 53 Ind. L. Rev. 461 (2020).
END FOOTNOTES