For starters, the green book provided a timeline for the Biden administration’s proposed increase in the corporate income tax rate. If enacted, the corporate rate would increase from 21 to 28% for taxable years beginning after Dec. 31, 2021. Fiscal-year taxpayers would be subject to the 21% rate, plus 7% times the portion of their taxable year that occurs in 2022 for the transition year that begins after Jan. 1, 2021 and before Jan. 1, 2022.
If enacted, the corporate rate would increase from 21 to 28% for taxable years beginning after Dec. 31, 2021.
Global intangible low-tax income (GILTI) changes
Currently, U.S. shareholders of a controlled foreign corporation are subject to U.S. tax under the GILTI rules that were enacted as part of the Tax Cuts and Jobs Act (TCJA) in 2017. As previously discussed, the Biden tax proposals would increase the GILTI rate to at least 21% for corporate owners by reducing the current 50% Section 250 deduction to 25%, eliminating the current 10% GILTI exclusion for qualified business asset investment (QBAI), and shifting the GILTI calculation from a global consolidated taxable income number to jurisdiction-by-jurisdiction calculations. Foreign tax credit calculations would also conform to a jurisdiction-by-jurisdiction basis, including foreign tax credits in the branch income basket.
The green book describes some additional modifications to the GILTI regime, including:
- Repeal of the high-tax exception (HTE) election (for both Subpart F and GILTI) that allows a U.S. shareholder to exclude CFC income taxed at a foreign effective rate that exceeds 90% of the U.S. corporate income tax rate.
- A provision that creates special income inclusion rules for foreign-controlled domestic corporations that own CFCs so that their treatment complies with the Organization for Economic Cooperation and Development’s (OECD) Base Erosion and Profit-Shifting (BEPS) rules and aligns with the Biden administration’s SHIELD rule (discussed below).
- Repeal of the GILTI exemption for foreign oil and gas extraction income (FOGEI).
The new guidance also specifies that these provisions would be effective for tax years beginning after Dec. 31, 2021, ending speculation about the possibility that the proposals were intended to be retroactive.
Notably, while the stated GILTI tax rate would be 21%, there is a question of the true effective rate if the 80% foreign tax credit haircut rate remains in effect. Additionally, two open questions that have quickly surfaced regarding the GILTI changes are if moving to a jurisdiction-by-jurisdiction approach would open the opportunity to revisit carryover of tested losses, as well as if GILTI basket foreign tax credits will change to allow carryforward/carryback.
Disallowance of deductions attributable to exempt income
The green book expands the application of a provision in the tax law that prohibits taxpayers from taking deductions for certain expenses related to the production of income that’s exempt from tax or taxed at a preferential rate. In this case, expenses that are properly allocable to the reduced-rate portion of GILTI income due to Sec. 250 deduction, as well as exempt Sec. 245A dividends received from specified 10% owned foreign corporations would no longer be deductible.
As an example, a dividend exempt under Sec. 245A could cause the loss of the allocable interest expense deduction. The proposals would also adjust the foreign tax credit limitation calculation by eliminating a favorable provision that causes these same allocable expenses to be added back to the numerator and denominator of the limitation calculation, generally resulting in a higher foreign tax credit limitation.
Limitations on corporate inversions
The new Treasury explanations include details about Biden administration proposals to limit corporate inversions. The proposal would eliminate the two-tier 60% partial inversion and 80% complete inversion thresholds and would replace them with a greater than 50% threshold for complete inversion.
Regardless of the level of shareholder continuity, the Biden administration proposals would hold that an inversion occurs if:
- Immediately prior to the acquisition, the fair market value of the domestic entity is greater than the fair market value of the foreign-acquiring corporation.
- After the acquisition, the expanded affiliated group is primarily managed and controlled in the United States.
- The expanded affiliated group doesn’t conduct substantial business activities in the country in which the foreign-acquiring corporation is created or organized.
The proposal would eliminate the two-tier 60% partial inversion and 80% complete inversion thresholds and would replace them with a greater than 50% threshold for complete inversion.
The proposals go on to expand the definition of inversion to include:
- A direct or indirect acquisition of substantially all of the assets constituting a trade or business of a domestic corporation.
- Substantially all of the assets of a domestic partnership.
- Substantially all of the U.S. trade or business assets of a foreign partnership.
The proposal could also treat certain distributions of stock of a foreign corporation by a domestic corporation or domestic/foreign partnership as an inversion if the foreign corporate stock equals substantially all assets or trade or business assets of the distributing corporation or partnership.
The new rules would be effective for transactions that are completed after the date of enactment.
Foreign-derived intangible income deduction (FDII) repeal
The green book reiterates earlier statements from the Biden administration about repealing the FDII regime, but it takes a step further in stating that the repeal would raise revenue that “can be used to incentivize research and development in the United States more directly and effectively.” The hope is that this would lead to a modification of rules that would require the capitalization of R&D costs in the future, although the proposals don’t specifically mention this option.
Repeal of base erosion and anti-abuse tax (BEAT)
As discussed previously, the Biden administration is looking to develop a more stringent program to penalize U.S.-based multinationals that concentrate income in low-tax jurisdictions. The new “stopping harmful inversions and ending low-tax developments” (SHIELD) rule will apply to financial reporting groups that include at least one U.S. corporation, U.S. partnership, or a U.S. trade or business (branch with U.S. income) and that have annual global revenues of $500 million, a much larger scale than BEAT, which only looked at U.S. trade or business income.
SHIELD would disallow certain U.S. tax deductions if the financial reporting group includes one or more low-taxed members and the U.S. entity makes any gross payment to a member of the financial group. The low-taxed members are defined as any member whose income is subject to an effective tax rate, determined on a jurisdictional basis, below the designated minimum tax rate, determined by reference to the rate agreed to under the OECD’s “Pillar Two”. If SHIELD is in effect before the Pillar Two rate is determined, the designated rate will be 21% (or the GILTI rate). There is some question as to the mechanics of determining the effective tax rate, as the proposal largely refers to the financial accounting of the consolidated financial group statements determined under U.S. GAAP, IFRS, or other authorized financial statement information.
The SHIELD rules would completely disallow otherwise deductible direct payments made to low-taxed members. A portion of gross payments made to high-tax members are still deemed made to low-taxed members and are not allowed, based on the extent of the group’s ratio of low-taxed profits compared to its overall profits, based on the consolidated group financials. Additionally, payments for cost of goods sold (COGS) to members also result in a loss of other deductions up to the gross amount considered paid to low-taxed members. The result of the mechanics is a cliff effect on deduction disallowance, rather than a “top-up” mechanic to get to a targeted global minimum tax rate.
The proposal did provide Treasury the authority to exempt payments to investment funds, pension funds, international organizations, and nonprofits, as well as payments of financial groups that meet minimum effective level of taxation on a jurisdiction by jurisdiction basis, providing a nod to U.S.-parented groups that should meet a minimum level of taxation under the changes to the GILTI tax regime.
Recognizing the long runway to negotiations with the OECD on a Pillar Two minimum tax rate, the effective date for the SHIELD provisions would be for tax years beginning after Dec. 31, 2022.
Limitation of foreign tax credits from sales of hybrid entities
The Biden administration proposal would treat gain recognized in sales of foreign hybrid entities or triggered by classification elections on foreign entities as capital from the sale of stock. By treating the character and source of the gain as a capital gain, it would deny any increase to foreign source income. This would limit the ability to take foreign tax credits on these transactions. The fig leaf rationale for this change is to create parity with current rules of Sec. 338(h)(16), which prevents the change in character from capital to ordinary earnings in a stock sale treated as an asset sale.
Interest expense limitations
For financial reporting groups with $5 million or more of net interest expense reported on the U.S. tax returns, the Biden administration proposal would impose an additional limit on deductible U.S. tax interest expense. The deductible U.S. interest expense would be limited to the proportionate share of the taxpayer’s financial statement interest expense, determined by the ratio of their financial statement earnings (EBITDA) to the total financial reporting group earnings.
In the alternative, a member can elect a limitation based on member’s interest income plus 10% of the member’s adjusted taxable income (as defined under Sec. 163(j)), or this method will be used if the member doesn’t substantiate its proportionate share of the group’s net interest expense for financial reporting purposes.
The interest limitation rules under Sec. 163(j) will still apply, and a taxpayer will use the lower limitation of these two amounts to determine the disallowance, and any amount disallowed can be carried forward indefinitely for use on future returns. There is not currently any mention of an excess interest limitation carryforward, but it could appear in future legislative detail.
The proposal targets the over-leverage of U.S. entities by multinational groups to shift U.S. profits through interest income to lower-tax jurisdictions and interest expenses in the U.S. entity; however, the proposal only appears to apply only to U.S. inbound-owned groups. The proposal defines the U.S. subgroup as any U.S. entity that’s not owned directly or indirectly by another U.S. entity and includes all members, domestic or foreign, that are owned by the U.S. entity.
This proposal would be effective for tax years beginning after Dec. 31, 2021.
Book minimum tax
The green book also restates the Biden administration’s proposal for a 15% minimum tax on worldwide book income for corporations with annual global group income in excess of $2 billion. In yet another example of the intersectionality of financial statement or book income with tax calculations in the Biden proposals, the minimum tax base would be pretax book income after book net operating losses are applied. The minimum tax would allow deduction of general business credits and foreign tax credits, and taxpayers would be allowed to claim a book tax credit against regular tax in future years, similar to the former alternative minimum tax credit.
The green book also restates the Biden administration’s proposal for a 15% minimum tax on worldwide book income for corporations with annual global group income in excess of $2 billion.
This proposal would be effective for tax years beginning after Dec. 31, 2021.
These proposals will be sent to Congress where they are likely to be debated at length and significantly modified. The key takeaway at this point is that the administration has set forth some key concepts that will shape the debate in the months ahead.
To learn more about how these proposals might affect your business, please contact a Plante Moran advisor to discuss your specific facts and circumstances.