US bill proposing tax on corporate book income could undermine R&D incentives

By Doug Connolly, MNE Tax

A bill announced by US Senator Elizabeth Warren (D-Mass.) on August 9 would impose a tax on the income that large corporations report to their shareholders with an aim to prevent those corporations from using “loopholes” – including tax incentives, like the research and development (R&D) tax credit – to avoid paying taxes.

President Biden included a similar plan in his corporate tax proposals released in May, and he floated the proposal this summer, unsuccessfully, as a potential fundraiser for a bipartisan infrastructure bill. Biden’s plan envisions a 15% minimum tax on worldwide book income of corporations that have worldwide book income in excess of USD 2 billion.

On the other hand, Warren’s bill, titled the Real Corporate Profits Tax Act, would impose a 7% tax on the financial statement income of corporations in excess of USD 100 million. For foreign corporations, the tax would apply with respect to the portion of their financial statement income that is effectively connected with a US trade or business.

Both plans aim to address the same problem: large corporations reporting substantial profits to shareholders while avoiding paying federal US income taxes on those profits. At least 55 large US corporations paid no income tax in 2020 while reporting a total of more than USD 40 billion in profits, according to a review of public financial reports by the Institute on Taxation and Economic Policy.

There are several reasons why corporations are able to do this. As Kimberly Clausing, US Treasury Deputy Assistant Secretary for Tax Analysis, explained in response to a question from Senator Warren about Amazon’s low effective tax rate in a March Senate Finance Committee hearing:

[T]here are lots of reasons … why US companies end up with very low tax burdens. And I think that the one that we focus on here the most is the international profit shifting problem. … There are also other reasons why companies pay less in tax. Those might include receiving large R&D credits or having losses in past years that might reduce their tax liability.

A tax to capture the gap between corporate book income and tax income accordingly would target not just tax evasion techniques like profit shifting but also tax incentives that Congress has intended, such as the R&D tax credit. This would be true at least for the large companies affected by such a tax – Warren’s bill would reportedly apply to roughly 1,300 public companies.

Congress can change its mind, of course, about how much large profitable corporations should benefit from R&D tax incentives or other provisions aimed at incentivizing investment, like accelerated depreciation.

However, this does not seem to be the intent of the current administration. Although Biden’s proposed tax on corporate book income could similarly diminish the benefit of R&D tax incentives, Treasury Secretary Janet Yellen has emphasized that strengthening R&D tax incentives is a priority for Biden. The potential impact of the proposed book income tax on R&D incentives, at least in Biden’s case, seems to be more the side effect of a blunt instrument than a conscious policy choice.

However, the Administration has yet to propose any specific R&D tax provisions. As such, it remains to be seen what the net effect of any such R&D provisions would be when combined with any book income tax that might make it into the Democrats’ corporate tax reform efforts in the coming months.