By Kyle Pomerleau, Senior Fellow, American Enterprise Institute, Washington, D.C.
The Biden Administration recently released its fiscal year 2023 budget, which included additional reforms to the tax treatment of multinational corporations. These reforms are meant to further align the U.S. tax code with OECD’s Pillar Two model rules and would be on top of those reforms included in the now-stalled Build Back Better Act. The administration has argued that the global tax deal would enhance the competitiveness of U.S. multinational corporations, but differences between its proposed reforms and Pillar Two rules could leave U.S. companies at a competitive disadvantage.
Since entering office, the Biden Administration has focused on negotiating and implementing a global deal on taxing multinational corporations. A major component of this deal is a minimum tax on the profits of multinational corporations called Pillar Two. Pillar Two includes three main components: (1) an income inclusion rule (IIR), which taxes foreign profits of domestically headquartered corporations at a minimum rate of 15%; (2) an undertaxed payment rule (UTPR), which acts as a backstop to the IIR and can tax foreign headquartered corporations; and (3) a domestic minimum tax, the “qualified domestic minimum top-up tax” (QDMTT), which gives countries priority to tax low-taxed profits earned in their jurisdiction.
Most of the administration’s reforms that move towards Pillar Two are included in the now-stalled Build Back Better Act (H.R. 5376). The Build Back Better Act would increase the tax rate on foreign profits from 13.125% to 15.8%, require companies to compute Global Intangible Low-Tax Income (GILTI) on a country-by-country basis, reduce the exclusion for tangible assets from 10% to 5%, reform the Base Erosion and Anti-Abuse Tax (BEAT), and enact at 15% minimum tax on financial statement income. The fiscal year 2023 budget further proposes replacing BEAT with an UTPR and a QDMTT and raising the corporate income tax rate from 21% to 28%.
Although these reforms would raise the tax burden on U.S. multinational corporations, the Biden administration argues that enacting the global tax deal would improve their competitiveness. Currently, the U.S. is the only country with a minimum tax on foreign profits, and if all countries enacted Pillar Two-style rules, U.S. and foreign corporations would be on a level playing field. This would result in a “less distortive international tax system.”
This argument relies on the U.S. and other countries enacting the same—or at least highly similar—policies, however. Currently, the administration’s proposed reforms contain meaningful differences from Pillar Two model rules.
Some of the differences between Pillar Two and the Biden administration reforms are obvious. Pillar Two sets out a 15% minimum tax on foreign profits through the income inclusion rule, while the Biden administration proposes taxing foreign profits through GILTI at a rate of 21%.
Other differences are subtler. GILTI in the Build Back Better Act would allow corporations to exclude 5% of tangible assets from foreign profits when calculating taxable income. In contrast, Pillar Two’s IIR would allow corporations to exclude more: 5% of assets and 5% of payroll. The IIR would, in most cases, not claw back timing benefits such as accelerated depreciation. GILTI, however, requires U.S. companies to recompute foreign taxable income under straight-line depreciation, which results in a top-up tax if companies benefit from accelerated depreciation in a foreign jurisdiction. Lastly, the IIR rule would only apply to companies with revenues of above EUR 750 million (approximately USD 820 million), while GILTI applies to all corporations.
Differences also exist concerning the domestic minimum tax. Under Pillar Two, the 15% domestic minimum tax (QDMTT) closely mirrors its minimum tax on foreign profits. Each tax has the same exclusion for assets and payroll, adjustments for timing differences, and excludes companies with revenues under EUR 750 million. The Biden administration’s domestic minimum tax, the 15% minimum on financial statement income, would have no exclusion for assets or payroll and would scale back accelerated depreciation. It would also apply to foreign income. Although it would apply to fewer companies by excluding those with profits under USD 1 billion.
A consequence of being out of step with Pillar Two is that taxes could still influence a company’s decision to locate headquarters in the United States. A multinational corporation located in the United States that operates in foreign jurisdictions could face a more significant tax burden on foreign profits than if they were located in a country that simply complied with Pillar Two. As a result, companies would continue to have an incentive to relocate their headquarters overseas.
Another consequence of placing a higher tax burden on foreign profits than Pillar Two is that U.S. multinational corporations could lose out on overseas investment opportunities to foreign competitors. This is because the after-tax return on a given investment may be higher in the hands of a foreign corporation than it would be in the hand of a U.S. multinational corporation. This impact on competitiveness could be even greater for medium-sized multinational corporations based in the U.S. This is because all U.S. multinational corporations—regardless of size—are subject to GILTI. In contrast, small-to-medium size foreign-based multinational corporation would fall under the EUR 750 million revenue threshold of Pillar Two and would only face that country’s existing anti-avoidance rules.
The administration’s proposals would also work against the goal of the global minimum tax to reduce the incentive to shift profits into low-tax jurisdictions. Profit-shifting incentives are driven primarily by differences in statutory tax rates and setting a floor of 15 to 21% will reduce the tax savings of shifting profits into zero-tax jurisdictions. Meanwhile, the administration’s proposal to raise the corporate tax rate to 28% would tend to increase the incentive to shift profits out of the United States.
The Biden Administration continues to work towards enacting a U.S.-version of Pillar Two and has advertised these reforms as enhancing U.S. competitiveness, but this depends on the final details of any reform. The current details suggest that there will continue to be a tax disadvantage to being a U.S.-based multinational corporation.
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Kyle Pomerleau is a senior fellow at American Enterprise Institute in Washington, D.C.
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