by Julie Martin
The US intends to issue proposed tax regulations next month addressing the section 965 transition tax followed by year-end guidance on the GILTI, BEAT, and other international tax provisions introduced in the 2017 Tax Cuts and Jobs Act, said Lafayette (Chip) G. Harter, Deputy Assistant Secretary (International Tax Affairs) at US Treasury during the 2018 OECD International Tax Conference, held June 4–5 in Washington.
“We’ve got a pretty decent draft of the [section] 965 transition regulations drafted and it’s begun its way through the review and editing process so I think we are on schedule to get those out by the end of July,” Harter said.
Concerning the other components of the 2017 US tax international tax reform, Treasury’s goal is to release a “fairly comprehensive” set of proposed regulations by year-end so that corporations can rely on the guidance when preparing their year-end financial statements, he said.
The plan is to then finalize the proposed regulations by June 2019 so they fall within the section 7805(b) retroactivity window and thus can apply seamlessly back to January 1, 2018, Harter told the conference, an annual event co-sponsored by the OECD, USCIB, and BIAC.
Harter said crafting international tax guidance to implement tax reform has been “a daunting task” because the reform so fundamentally changed the US international tax system.
US tax officials have been compiling a list of what needs to be done, he said, consulting with taxpayers to determine which aspects of the new law should be prioritized for clarification. Harter said that he has personally attended over 200 such taxpayer meetings. The government now has a good handle on what guidance needs to be drafted and a plan to accomplish it, he said.
GILTI expense allocation
Harter said that the most difficult issue Treasury needs to address is the interaction between the new global intangible low-taxed income (GILTI) provisions and expense allocations.
“There is a real tension between, on the one hand, making the GILTI a separate foreign tax credit limitation basket and, on the other hand, saying the GILTI is an antiabuse backstop to a territorial system and that the US does not seek to assert residual tax in jurisdictions if you paid at least the 13-1/8 foreign tax [rate],” he said.
Harter said Treasury understands the negative impact the new rules have on taxpayers that have considerable expenses allocated against GILTI basket income and that have excess credits in the GILTI basket.
“We are hoping to take a somewhat pragmatic approach that to some extent adjusts the existing expense allocation rules and implements a foreign tax credit look-through rule for related party payments in the context of having yet another basket to deal with,” Harter said.
He said the government’s solution “will not be a thing of conceptual beauty ” and is unlikely to make everyone happy.
The government must “walk a very fine line” between providing relief so that the law does not penalize companies that locate their corporate headquarters in the US but, at the same time, not open up opportunities for cross-crediting foreign tax credits, he explained.
BEAT’s ‘rough edges’
Harter also said that Treasury is aware that the new base erosion and antiabuse tax (BEAT) can have harsh effects on international banking and insurance and on some service industry models. Complaints about the BEAT were raised in a letter written by finance ministers from Italy, Germany, France, the UK, and Spain even before the US tax legislation was final, he noted.
“We are exploring the limits of our authority in terms of what we can do to take off some of the rough edges where the results are perhaps unduly harsh,” Harter said.
He said that the government is aware of the Senate tax bill’s floor colloquy between Sen. Rob Portman, R-Ohio, and Senate Finance Committee Chair Orrin G. Hatch, R-Utah, relating to the services cost method exception to the BEAT. Treasury is “exploring what we can do within our authority with respect to those types of costs,” he said.
The issue concerns how the BEAT applies to payments made by a US corporation to a foreign related party in exchange for services if those intercompany payments include a markup.
Harter also warned that there are limits to Treasury’s power to provide relief from the BEAT to taxpayers through tax regulations.
“There some aspects of the BEAT that I just don’t think we can do much, if anything, about, such as the fact that it does limit the ability to get the benefit of foreign tax credits. That seems hardwired into the statute notwithstanding that foreign tax credits are generally not viewed as an affirmative benefit,” he said.
Harter added that the US will not be able to address everything in the coming regulation projects. For example, he reported that one taxpayer asked for guidance on whether live chickens in Peru can be considered a cash equivalent under the transition tax. “Some issues people will need to exercise a little reasonable judgment on,” he said.
US reform, State aid, digital economy
Harter maintained that the 2017 US tax reform is the most far-reaching implementation of OECD/G20 base erosion profit shifting (BEPS) plan principles to date.
The combination of the transition tax and the GILTI is significant, he said. Now, all post-1986 earnings of US-based multinationals previously held untaxed offshore will be taxed between 8 and 15 percent, which is a higher tax rate than in many countries. Moreover, going forward, the offshore earnings of US MNEs will be subject to a combined US and foreign tax rate of at least 13-1/8 percent. Also, the US has adopted interest stripping and anti-hybrid rules, he observed.
Harter said that this changed environment undercuts the EU Commission’s theory in the Apple State aid case that US company subsidiaries can have earnings that are “stateless” and subject to tax nowhere.
Tax reform also changes how one must view taxation of digital firms, he said. With US tax reform, the earnings of US-based digital companies will now be taxed in the US at respectable rates, Harter said. He acknowledged, as US officials have in the past, though, that issues of income allocation may need updating to reflect new business models, but said that such updating should not be limited to the digital economy.
Corporate tax rate
Grace Perez-Navarro Deputy Director, OECD Centre for Tax Policy and Administration, said she supported the US’s decision to reform the corporate tax by lowering the tax rate to 21 percent. Rather than promoting a “race to the bottom,” the US’s move appears more like a “hop to the middle,” Perez-Navarro said, as the new tax rate is in the middle of the pack for OECD and G20 countries.
Michael Graetz, Alumni Professor of Tax Law at Columbia Law School, characterized the US tax legislation as being very unstable. Extension of the expiring provisions in the law would double the law’s cost from 1.5 trillion to about 3 trillion, he observed, adding to the US’s already unsustainable deficit.
Graetz also noted the partisan nature of the 2017 tax law’s passage and said that though he believed it would be the wrong move, he would not be surprised if the corporate rate was later increased to 25 percent.
Graetz said that the 2017 US legislation also makes clear the questionable directions of both the European Commission’s State aid efforts and the idea of treating the digital economy as if it was a single topic. The real problem is where and how intellectual property income, especially marketing intangibles, should be taxed, he said, not State aid or digital goods and services.
Graetz said the GILTI and BEAT reflect US Congress’ dissatisfaction with transfer pricing rules based on value creation and demonstrate a search for alternatives, even those that don’t seem likely to function well. He said the UK and Australia’s diverted profits tax and the EU State aid cases reflect a similar dissatisfaction and willingness to engage unique and controversial unilateral measures.
Global discontent
Pam Olson, US Deputy Tax Leader and Washington National Tax Services Leader at PwC, said that despite all the work done on BEPS, global discontent remains with the cross-border tax rules.
“BEPS tackled the politically and publically easy part — closing loopholes — but proposals like the digital service tax, actions like State aid, the diverted profits tax, etc., make clear to me at least that the system is wholly unstable. And that is because the hard part is yet undone and the hard part is determining who gets to tax what no long longer falls through the cracks.”
Olson said the old rules for jurisdiction to tax are becoming a thing of the past. Countries need to have a multilateral conversation on what the future should look like, she said.
Julie Martin
Julie Martin is the founder of MNE Tax. She edits the publication and regularly contributes articles on new developments in cross-border business taxation.
Julie has worked as a tax journalist and editor for more than 13 years. Prior to that, she worked as an in-house tax attorney in New York. She also holds an LLM in taxation from New York University School of Law.
Julie can be reached at [email protected].
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