US Senate unveils international tax reform draft legislation

By Doug Connolly, MNE Tax

Senate Finance Committee Chairman Ron Wyden (D-Ore.) on August 25 released draft legislation for international tax reform that would retain but modify – and, partly, rename – key provisions of the Republicans’ 2017 tax law, including the global intangible low-taxed income (GILTI) provision, foreign-derived intangible income (FDII), and the base erosion and anti-abuse tax (BEAT).

By stopping short of repealing FDII and BEAT, the legislation does not go as far as Biden’s proposed tax reforms. However, it would still repeal the qualified business asset investment (QBAI) exemption and otherwise broadly overhaul GILTI. The draft legislation largely leaves open the question of rates.

With the House’s adoption on August 24 of the budget resolution that the Senate adopted August 11, Democrats have cleared a path for crafting a reconciliation bill – replete with corporate tax reform – that could pass the Senate with a simple majority.

Country-by-country minimum tax, foreign tax credits

The legislation would rename GILTI “country-by-country inclusion of low-tax income” – ostensibly setting the provision up for a familiar-sounding “CILTI” acronym, although not explicitly referenced.

Unlike the current GILTI provisions, which allow jurisdictional blending, the legislation would require country-by-country calculation for application of the minimum tax. Democrats have sought to make the change to country-by-country calculation to give the provision more teeth by preventing corporations from using profits earned in high-tax jurisdictions to offset low-taxed profits reported in tax havens. The change to country-by-country calculation would also be necessary to make the provision align with the global minimum tax under negotiation internationally in the OECD/G20 plan.

Under the draft legislation’s amended provision, top-up tax would apply to income earned in a foreign country that is subject to an effective rate of tax that is below the “GILTI” rate. A high tax exclusion would apply to income earned in a foreign country that is subject to a rate higher than GILTI. The legislation would also extend the high-tax exclusion rule to foreign branches.

There would also be a “high-tax tested income” exclusion from tested income in GILTI for income that otherwise would be taken into account under GILTI but faces an effective rate – as adjusted by a “foreign tax credit haircut” – greater than the GILTI rate. The “haircut” could be set “anywhere from zero to 20 percent.” Corresponding changes would apply under subpart F.

The legislation would repeal the tax exemption for 10% deemed returns on QBAI owned abroad. Democrats have argued that the QBAI exclusion incentivizes US corporations to invest in more tangible assets abroad, as opposed to the US, to increase their minimum tax exclusion.

In addition, amended foreign tax credit limitation rules would apply for research and certain other expenses for activity conducted in the US. Expenses for research and experimentation and for “stewardship” activities conducted in the US would be treated as 100% allocated to US source income for purposes of determining the foreign tax credit limitation. No change in tax treatment would apply for such activities conducted outside the US.

FDII and BEAT

Consistent with Wyden’s international tax reform framework announced in April – and in contrast to Biden’s plan – the legislation would retain the deduction for FDII. However, it would rename the provision “foreign-derived innovation income.” The draft legislation leaves open the amount of the deduction. The to-be-determined rate would apply to “domestic innovation income,” which would include qualified research and development (R&D) expenditures and qualified worker training expenses.

Regarding the BEAT, the legislation would retain the provision but modify it to restore full value to domestic business credits and to add a second rate bracket for base erosion income. Accordingly, the legislation would not replace BEAT with Biden’s proposed alternative SHIELD (stopping harmful inversions and ending low-tax developments). However, Senate Democrats are evaluating how to further incorporate the aims of Biden’s SHIELD proposal into BEAT amendments.