International Tax Reform…It Ain’t Over Yet

If the past 30 days have taught us anything, it is that Yogi Berra was right when he said, “It ain’t over till it’s over.” The fourth quarter of 2021 will keep taxpayers on the edge of their seats in anticipation of what tax law changes may be included in the Democratic infrastructure bill. Considering the Administration’s Green Book, the policy papers of members of Congress, the previous deluge of comments that have been publicly and privately made to the Treasury and the IRS, it is quite clear that no provision is “safe” from modification. Moreover, even when the Democrats appear to agree regarding an underlying policy, their approaches to implementation of that policy vary wildly. In April, we discussed the international tax reform framework that Senate Finance Committee Chairman Wyden and committee members Brown and Warner released. Now that both the House and the Senate have approved a reconciliation resolution, the work on the reconciliation bill can begin in earnest. Last Wednesday, Wyden, Brown, and Warner released a discussion draft which addresses some of the components of their international tax framework. This alert highlights some of the key provisions of the proposal, because while it is possible that the language in the final reconciliation bill may be different, due to the proposed effective dates (as discussed below), taxpayers should start to consider the potential impact on their operations.

• GILTI would be calculated without the 10-percent deemed return on tangible property reduction (generally known as the QBAI reduction).

A&M Insight: The stated policy of the proposal is that the QBAI reduction incentivized taxpayers to move their tangible assets offshore in order to reduce their GILTI inclusion. From a practical perspective, it is unclear how many taxpayers moved their tangible assets due to the QBAI reduction. Rather, this proposal is one of several, that moves the U.S. closer to shifting back from a semi-territorial taxation system to a world-wide taxation system.

• GILTI, subpart F and foreign branch income would be calculated on a country-by-country basis due to a mandatory high-tax exception. Under the proposal, after applying certain aggregation rules, all GILTI tested income, subpart F income, and foreign branch income that are subject to an effective tax rate in excess of the federal corporate tax rate (adjusted by the section 250 deduction, if applicable), and all tested loss (in the case of GILTI) would be viewed as high-tax income and not subject to US tax.

A&M Insight: The imposition of country-by-country calculations can have major implications for the GITLI calculation, as taxpayers will no longer be allowed to net losses from one jurisdiction against the income of another. Additionally, the proposal, noting that it is under study, does not currently provide a mechanic to allow taxpayers to ever take advantage of the net losses generated in a jurisdiction, because the GILTI computation is an annual concept.

Example: USSH owns all of the stock of CFC, which operates in Country X and Country Y. In Year 1, CFC earns $110 in Country X and loses $100 in Country Y. In Year 2, CFC earns $150 in Country X and $100 in Country Y. Currently, the USSH would have tested income of $10 in Year 1 ($110 – $100) and $250 in Year 2 ($150 + $100). Under the proposal, the USSH would have tested income of $110 in Year 1 (all attributable to Country X) and $250 in Year 2 ($150 attributable to Country X and $100 Country Y).

As a result, this will encourage taxpayers to re-optimize their global organizational structure so that tested units that generate losses are within the same jurisdiction as those that generate income. While that is certainly the intention of the proposal, it places an additional burden on post-transaction integration of businesses. Additionally, this creates friction between the corporate and tax departments, especially when new ventures are being created. From a corporate perspective, if a venture is intended to be operated in a jurisdiction it is best to start that venture in that jurisdiction. However, because “startup losses” may result in tested losses, to the extent the venture can be started in a jurisdiction where the taxpayer has existing operations, the taxpayer would be able to utilize those startup losses to offset its operating income and then transfer the venture to the new jurisdiction once it is established and profitable (i.e., it becomes a new tested unit). This proposal will cause U.S.-based multinationals to make operating decisions based on taxes, which seems contrary to the global push toward Environmental, Social, and Governance (ESG) goals. Lastly, if enacted, this will increase compliance burdens, both from a calculation and a reporting perspective.

• The percentage of GILTI that would be eligible for the section 250 deduction is unclear, although it is clear that the effective tax rate on GILTI will be increased.
• The calculation of foreign tax credits would exclude all foreign taxes paid or accrued with respect to high-tax tested income and would adjust the taxes deemed paid on GILTI and subpart F, which will bring added complexity.
• The deduction for foreign derived intangible income (old FDII) would be replaced with a deduction for foreign derived innovation income (new FDII). While old FDII was based on the domestic corporation’s foreign intangible income, new FDII focuses on a domestic corporation’s foreign income that is derived based on domestic research and development and qualified job training expenses.

A&M Insight: The proposal shifts the focus of the deduction to apply only to expenses that are incurred in the current year. As a result, new FDII may not be as useful as old FDII due to the timing lag associated with research and development expenses and the resulting revenue. Further, the addition of new FDII diminishes the hope that as part of the partisan infrastructure package, the TCJA changes to section 174 (which will require taxpayers to capitalize and amortize their research and experimentation costs over a five-year period beginning in 2022) will be reversed or delayed.

A&M Tax Says: 

While the proposal will generally have adverse effects on taxpayers, there are two positive developments. First, the proposal does not adopt the Green Book’s Stopping Harmful Inversions and Ending Low-Taxed Developments (SHIELD). Instead, it makes minor changes to the Base Erosion Anti-Abuse Tax (BEAT) and leaves open the potential implementation of certain aspects of SHIELD. Second, and even more importantly, the proposals are generally proposed to be effective for taxable years beginning after the date of enactment. Therefore, taxpayers are still afforded an opportunity to review the proposed legislation and determine how it may impact them, and what transactions they should consider before the new law comes into force. As tax reform unfolds, it is imperative that clients collaborate with their trusted advisors to navigate the landscape during this uncertain time. A&M will continue to monitor the tax reform process and will provide timely updates on new developments. If you would like to discuss your particular situation or the potential tax reform changes, including potentially modeling scenarios or identifying planning opportunities, please feel free to contact Kevin M. Jacobs or Albert Liguori.

https://www.alvarezandmarsal.com/insights/international-tax-reformit-aint-over-yet