A good global minimum tax would target stateless income. Professor Reuven S. Avi-Yonah recently stated that the “global intangible low-taxed income regime is the best part” of the Tax Cuts and Jobs Act. While I couldn’t disagree more, perhaps this should be read in light of the suggestions for improving the TCJA that constitute the majority of Avi-Yonah’s article. After all, a global minimum tax is certainly needed to prevent stateless income, but the GILTI regime encourages it.
Avi-Yonah notes four major problem areas for the GILTI regime: (1) the exemption for 10 percent of qualified business asset investment and the participation exemption; (2) global netting, or “the ability to cross-credit within the GILTI basket”; (3) “the 50 percent deduction is allowed before allocable U.S. shareholder deductions”; and (4) “the low GILTI rate creates yet another incentive to shift profits offshore.”
Perhaps Avi-Yonah is awfully clever in suggesting to keep the TCJA’s international provisions with simple tweaks. After all, the TCJA merely tweaked proposals that came from the Obama administration. I presume Avi-Yonah was a fan of the Obama administration’s minimum tax proposal — before it was altered to frustrate the OECD’s goal to eliminate stateless income, which has now been sanctioned through the GILTI regime’s 10 percent tax-free return on QBAI and use of a global netting approach.
The Obama administration’s final Treasury green book described a “19-percent minimum tax on foreign income” as a “per-country minimum tax on the foreign earnings of entities taxed as domestic C corporations (U.S. corporations) and their [controlled foreign corporations].” The green book went on to state that the “minimum tax would apply to a U.S. corporation that is a United States shareholder of a CFC.” Under the proposal, all foreign earnings could be repatriated without further U.S. tax because a one-time 14 percent tax would have been imposed “on earnings accumulated in CFCs and not previously subject to U.S. tax.”
So what would “the best part of the TCJA” look like if adjusted for the weaknesses that Avi-Yonah pointed out? GILTI would look like the Obama administration’s proposal of a minimum tax arising after conversion to a quasi-territorial system following a mandatory repatriation tax. And while the TCJA may not have been very original, the devil is always in the details.
Avi-Yonah’s suggested tweaks to GILTI would largely implement the Removing Incentives for Outsourcing Act (S. 20), introduced January 22 by Sen. Amy Klobuchar, D-Minn. That would mean repealing GILTI’s 10 percent tax-free deemed return on investments; determining net CFC tested income on a per-country basis; and eliminating section 250’s GILTI deduction, thereby increasing the minimum tax to 21 percent.
But this question remains: If there was an ideal minimum tax that comported with the OECD’s goals of preventing tax-motivated offshoring and encouraging neutrality, why did the TCJA tweak the green book proposal ? I’ve been asked this question a few times after writing a recent article covering the TCJA’s goals. While the TCJA concealed the means for achieving its goals through complex calculations and a lack of legislative history, I believe the goals were always clear.
The TCJA’s international provisions largely embody the policies underlying the Trump administration’s first budget, which was titled “America First: A Budget Blueprint to Make America Great Again.” Page 1 pulled no punches by stating that the budget “puts America first by keeping more of America’s hard-earned tax dollars here at home.” The view is that the United States shouldn’t be burdened with foreign taxes even if earned from foreign countries. This was a significant departure from the trajectory of tax proposals that America’s largest corporations had been facing after years of offshoring to benefit from foreign laws and customers.
The Trump administration’s view on using international collaboration to fairly allocate taxing rights was clear: America first. This clearly articulated budget goal was realized when the TCJA was enacted later that year. Fifty-one Republican senators signed the largest international tax overhaul in a single bill — after it was drafted in less than two months.
But when was the TCJA really drafted? Well, clearly, the starting point is found in the Obama administration’s green book. So why is the per-country change such a big deal?
Large U.S. corporations are known for taking advantage of no- or low-tax jurisdictions (single countries), and the OECD and EU were keen on putting a stop to it. There is a reason why Google, Amazon, Facebook, Apple, and others were warned to stay away from the Irish and Dutch sandwich structures: A minimum tax with an agreed-on apportionment was in the works to put an end to stateless income. It almost came to pass.
Then-House Ways and Means Committee Chair Kevin Brady, R-Texas, and then-House Speaker Paul Ryan, R-Wis., put forth their “A Better Way: Our Vision for a Confident America” blueprint, which pushed for a move to a destination-based cash flow tax, or border-adjustable tax. They were clear: “The Blueprint also ends the uncompetitive worldwide tax approach of the United States, replacing it with a territorial tax system that is consistent with the approach used by our major trading partners.” Trade and tax alignment was looking likely.
The blueprint continued:
American businesses invert for two reasons: to avail themselves of a jurisdiction with a lower rate, and to access “trapped cash” overseas. Those problems are solved by the lower corporate rate and the territorial system, respectively. In addition, border adjustments mean that it does not matter where a company is incorporated; sales to U.S. customers are taxed and sales to foreign customers are exempt, regardless of whether the taxpayer is foreign or domestic. . . . The cash-flow based approach that will replace our current income-based approach for taxing both corporate and non-corporate businesses will be applied on a destination basis. . . . Under the Blueprint, the bulk of the subpart F rules, which were designed to counter tax incentives to locate overseas, will be eliminated because there no longer will be any tax incentive to locate outside the United States. Businesses will be able to make location decisions based on the economic opportunities, not the tax consequences.
But not everyone wanted an approach consistent with that of America’s major trading partners. Avoiding subpart F was the name of the game. But others wanted to use tax to control economic decisions — namely, trade — to put America first. They did this by creating the world’s largest corporate tax haven through the TCJA. While concern for jurisdictions with low tax rates could have been addressed with a per-country minimum tax, interested parties pushed for tax laws allowing more gamesmanship. Now tax planning under subpart F has been sanctioned and bolstered by Congress to help U.S. corporations avoid foreign taxation so they can maximize profits for investors.
The argument against the border-adjustable tax was that it was “too complicated,” even though it was known that American manufacturers would end up “getting a credit,” which was by design and meant “to encourage companies to locate jobs and production” in the United States.
See, the OECD’s 15 action items could have moved forward if the Republican party’s leading contender for international tax reform — the blueprint’s border-adjustable tax — had been enacted alongside the Obama administration’s per-country minimum tax. All this was a real possibility at the beginning of 2017 and could have eliminated stateless income. U.S. corporations saw the stars aligning and feared a tax-planning supernova. Many of the policies underlying the 15 action items are now found in pillar 1’s apportionment goals and pillar 2’s global minimum tax. In line with its America first policies, the TCJA tweaked the Obama administration’s per-country proposal in an attempt to shield U.S. corporations from foreign taxes by allowing stateless income.
But were the tax benefits of the border-adjustable tax enough to move supply chains that had been designed to minimize material and labor costs? Would defenders of capitalism maintain their views against international competition? Plus, let’s face it, not everyone agrees with Abraham Lincoln that labor is the superior of capital.5 Philosophical beliefs often bend to the will of investors, as our capital markets have seen time and time again.
Ignoring borders by discarding the green book’s per-country approach, GILTI encourages stateless income by protecting the profits of U.S. corporations from being taxed by individual countries. GILTI adopts a global netting approach to support a superficial argument that U.S. corporations already pay a global minimum tax on income earned in all the countries they operate in. GILTI ensures stateless income can be offset by taxes paid in other countries. The 10 percent tax-free QBAI return, or unlimited deduction, further complicates a per-country minimum tax while shielding corporations from taxes by reducing the global tax base. In other words, U.S. corporations and their affiliates can claim their “income” is being taxed when the QBAI deduction is nothing more than a gift to corporations that seek shelter from foreign taxes.
The TCJA favored corporations and the markets to ensure that investors would bring their money to the United States. It certainly had the desired effect and increased earnings for foreign and domestic investors greatly.
But how long can this last with no real improvements to a country’s infrastructure and workforce? How long can a tax code filled with nationalistic policies that aim to prevent a fair allocation of taxes to individual countries survive without causing trade friction? Will the EU continue to allow the United States to thrive off an ever-expanding tax base because of jurisdictional claims that exclude risk, true control, or real activity? Will treaties, permanent establishments, and tariff threats pressure countries to relinquish control? Those questions were answered years ago with the actions of a coalition of countries that sought international collaboration to put a stop to the use of tax havens and the stateless income they allowed.
Robert Goulder pointed out that “excluding the United States, there is no reason for any country to refrain from enacting a [digital services tax], and to do so as expeditiously as possible.” Perhaps many source countries are bound by treaty to follow the PE principles, transfer pricing rules, and withholding tax restrictions, but the United States doesn’t seem bound by these principles.
Mindy Herzfeld recently wrote that “clear gains for the United States in the form of increased U.S.-source-based taxation on the residual profits of foreign-headquartered multinationals” would be needed for Congress to ever pass a deal that allows for the fair allocation of taxing rights that the world’s countries are looking for, as expressed by the OECD. But how much more can be gained while aiming to ensure U.S. corporations and their affiliates pay as little tax as possible? America first policies support grandfathering GILTI in the OECD pillar 2 global minimum tax, which would allow U.S. corporate income to continue to be sheltered while giving the United States more leverage in designing pillar 1 concepts of apportionment and income.
It is hard to deny that a revenue-losing measure would be a tough sell in Congress, particularly in light of the recession caused by the COVID-19 pandemic. But the optimism in Treasury Secretary Janet Yellen’s Senate testimony that indicated strong support for U.S. multilateral economic engagement and an OECD-led deal won’t be enough to reverse a trade war that Congress further provoked.
OECD countries, unilaterally or collectively, could create economic trade frictions that surpass those created by the TCJA and push the United States out of much of the global economy. Why waste time on DSTs if they are certain to pose no threat? The TCJA’s trade agenda, and its violations of international norms, have been known to the world since it was enacted.
The problem with playing chicken is that there is no certainty who will win. Mutually assured destruction is based on the premise that attacks by opposing countries would be equally harmful. Ultimately, the expanded jurisdictional taxing rights created by the TCJA will only be as successful as the world allows.
An enormous amount of the business profits and capital of U.S. corporations comes from overseas. Was the use of economic frictions and expanded jurisdiction to keep tax revenue in the United States a short-sighted play to improve investment that could ultimately prevent a long-term means to improve global prosperity? Will this strategy result in a tax rate race to the bottom — the tax revenue equivalent of mutually assured destruction? Global agreement to fairly apportion taxes and eliminate economic distortions that create incentives for base erosion and profit shifting were once goals across the aisle, with long-term economic prosperity as the objective.
The economic downturn from the COVID-19 pandemic has caused a greater need for tax revenue. Will economic barriers to ensure the prosperity of America first continue? Will the U.S. dollar always be the reserve currency, and will U.S. stocks be their investment equivalent? Will U.S. taxes continue to be so low relative to other countries’? How far must America first policies go before the world forces America to appreciate that its prosperity largely comes from international trade?
Some people will argue that this is largely about the losers — the so-called less developed source countries — that are unhappy with the winners, which are developed residence countries. The truth is that this is more about putting America first to gain control over the value of intellectual property at the cost of a trade war with the many countries America profits from through that IP.
The GILTI regime taxes U.S.-based multinational groups as U.S. residents and uses a global netting approach that shows little regard for the residence-based taxing power of the different countries that host the CFCs of those groups. It frustrates the taxing rights of more than 100 countries, many of which have been preparing to stake their own claim — a trend since 2017, when America first budget goals were realized through the TCJA.
Avi-Yonah concludes his article by stating that the deduction for foreign-derived intangible income “is a violation of the WTO Subsidies and Countervailing Measures Code and BEPS action 5 and should be discarded.” Perhaps his article is much like the TCJA in that both documents epitomize the saying “Don’t judge a book by its cover.” GILTI is a great example of this for several reasons, but most importantly: (1) netting the taxes of foreign countries encourages planning through low-tax jurisdictions and a foreign race to the bottom; and (2) the 10 percent tax-free QBAI return is a giveaway that distorts the concept of income and encourages profit shifting and offshoring. The 50 percent GILTI deduction to U.S. corporate shareholders further confirms who the true beneficiaries of the regime are.
Perhaps the TCJA can simply be tweaked as the Obama administration’s green book was. Perhaps no one must lose. Perhaps respect for sovereignty can be restored.
This article does not aim to predict possible outcomes. Countries are mounting a united front of DSTs, and the parties have been aligning for over a decade. The players have considered the outcomes. The political posturing seems to be continuing for no clear reason. They know what they stand to lose. But does everyone?