As expected, President Biden’s 2024 proposed budget included several changes to the tax treatment of foreign income. Although prior attempts to rewrite these tax rules stalled in Congress, with the European Union and others moving ahead on Organization for Economic Cooperation and Development proposals for minimum taxes on income of multinationals, it’s worth reviewing what Biden has proposed in this area.
The budget’s international taxation provisions are expected to raise over a trillion dollars over the next 10 years, the second largest source of new revenues in the budget behind increasing the corporate income tax rate from 21 percent to 28 percent. They include major changes to the US global intangible low-taxed income (GILTI) regime, the adoption of an undertaxed profits rule, and a repeal of the lower tax rate on some US exports.
What would change under the new GILTI regime?
By way of background, 2017’s Tax Cuts and Jobs Act (TCJA) applied a 10.5 percent tax rate to GILTI; the rate is scheduled to increase to 13.125 percent in 2026. In computing GILTI, companies may deduct 10 percent of Qualified Business Asset Investment (QBAI) –income from tangible assets such as buildings, plants, and equipment. Eighty percent of foreign taxes can be claimed as foreign tax credits (FTCs) against GILTI liability. For example, if a US company earns $100 of income, pays $5 in foreign income taxes, and owns foreign tangible assets worth $60, it would pay $6.4 of tax on GILTI (.105*[100-(.10*60)] – (.80*5)).
US multinationals currently can, with few restrictions, pool foreign income and tax credits across jurisdictions where they operate. This method, called “global averaging,” allows large companies to pay little taxes on their activity in low-taxed countries and tax havens by using credits from taxes paid to high-tax countries to offset GILTI liability.
Under the new regime, the tax rate on GILTI would increase to 21 percent. In addition, GILTI liability would be determined on a country-by-country basis. This would limit the ability of large multinationals to reduce their GILTI liability by using credits on taxes paid in high-tax countries to offset US taxes on income from low-tax countries.
The combination of a higher rate and applying the minimum tax country-by-country would put the US well ahead of requirements to comply with the OECD/G-20 Pillar 2 goal of a global minimum tax rate of 15 percent, although the pillar 2 tax is computed on a somewhat different base.
Taken together, the new GILTI regime would raise almost $500 billion over the next decade above and beyond the revenue raised by the proposal to increase the corporate rate to 28 percent.
A difference from some previous international tax reform proposals is the elimination of the 10 percent QBAI deduction. The White House says that the deduction creates perverse incentives to invest in foreign countries rather than domestically. But, while foreign investments in tangible assets do reduce US tax liability, there is little evidence that the deduction led US companies to invest overseas rather than domestically. In addition, moving to a country-by-country system reduces the value of the QBAI deduction, since most tangible property is not located in tax-havens or very low tax countries.
Because of the new limits on pooling foreign tax credits, the proposal raises the percentage of foreign taxes that are creditable against GILTI liability from 80 to 95 percent. The credits can be carried forward 10 years and net operating losses within a jurisdiction can be carried forward indefinitely.
The reform also includes limitations on the treatment of certain tax deductions and further limits the ability of multinational corporations to avoid US taxes on foreign-source income by doing a tax inversion and becoming foreign-resident.
The return of the Undertaxed Profits Rule
The second international tax provision in the budget is a proposal for an undertaxed profits rule (UTPR) to replace the current 10 percent base erosion and anti-avoidance tax (BEAT). It is similar to the one proposed in last year’s budget, and in combination with the GILTI reform, would align the US international rules with the requirements of Pillar 2. The new UTPR would take effect in 2025 and is expected to raise almost $550 billion over the next decade.
The UTPR applies to large US and foreign multinational groups with operations in low-taxed jurisdictions. Since it is implemented jointly with the GILTI reform, most of the additional revenues will likely come from foreign firms.
Under the provision, US subsidiaries of foreign multinationals can be denied deductions when they pay an effective tax rate below 15 percent on their offshore operations. The UTPR is limited by the amount of deductions multinationals claim in the US, and the provision may not always be able to raise the effective tax rate on offshore operations to 15 percent. But because of its economic size, the US is uniquely positioned to implement such a rule.
No more special tax regimes for US exports of intangibles
The budget plan would also repeal the foreign-derived intangible income (FDII) deduction introduced in the TCJA. FDII provides a deduction of 37.5 percent on qualified foreign-derived income, which is income from exports attributed to intangibles, and income from exports attributed to tangibles above a 10 percent return on investment. The deduction reduces the effective rate on this income to 13.125 percent.
Together with GILTI, FDII was supposed to provide an incentive for large US corporations to relocate their intangible assets (e.g. patents) to the US. It is unclear to what extent that goal has been achieved, and FDII was a major tax benefit for profitable multinational corporations. Repealing the provision is expected to raise $115 billion in revenue over the next decade. The additional revenue would be used to encourage research and development more directly in the US, but how is yet to be determined.
These reforms are ambitious. They would raise significant revenue from foreign profits of US corporations and make the US tax rules consistent with the proposals in the OECD’s Pillar 2 for taxing global profits of multinationals, which the US helped negotiate. The UTPR may lower foreign investment in the US, but because it falls mostly on foreign-owned companies, it will also make US-resident firms more competitive in the US market and potentially offset some of the anti-competitive effects of the tough GILTI rules.
While these proposals are unlikely to be enacted in their current form, they do lay down a marker for future efforts to reform US rules for taxing multinational companies.