You hear it everywhere: U.S. corporations don’t pay their fair share of taxes. They’ve hollowed out domestic industry by moving to cheaper, more tax-friendly countries. Whether or not you believe this narrative, it’s built on criticism that’s persisted for years. And now, the raft of tax policy proposals put forward by the Biden administration appears to mark the first comprehensive response.
The good news for U.S. companies with foreign operations — or those with plans to start them — is that there’s little in Biden’s “Made in America” proposals that should stop them from moving forward. If a foreign business expansion made economic sense before, it should still make sense in light of the proposed changes, even if tax bills end up being somewhat higher.
The more troubling news is that the proposals most likely to win approval are also the ones that signal a more arduous road ahead for U.S. multinationals. That’s because they come in the context of Biden’s plan to raise the overall corporate tax rate to 28% from 21%. They also arrive when U.S. and international reporting requirements are tightening. Together, those factors are likely to add significantly to companies’ compliance burdens.
Going forward, firms will need to invest more resources into international tax planning to ensure their strategies are right from the start. The tightening international environment means that mistakes that in the past could have been fixed on the fly are now more likely to incur financial penalties. As a result, it will be more vital than ever to have tax planning teams on the ground in relevant countries to ensure a complete understanding of local rules and their strategic implications.
But on which proposals should companies and management focus?
In my view, some of Biden’s propositions could struggle to win approval in Congress. The proposed 15% minimum book tax on large corporations falls into that category. The idea of using pre-tax book income is quite a radical departure from the current U.S. tax code. The move to assess the tax on worldwide income would also have major complications for the network of U.S. tax treaties with other countries. The plan to offer a credit to companies that onshore jobs while limiting the deductibility of expenses related to offshoring jobs also looks tough to implement in practice.
Exacerbating the effects of Biden’s plan is the dramatic rise in reporting requirements both in the United States and internationally.
That leaves these key areas that companies should worry about: Biden’s plan to increase the effective rate on global intangible low-tax income (GILTI) income, proposals to make it harder to get foreign tax credits, and a proposition to further tighten the “anti-inversion” rules.
The Trump administration introduced the 10.5% minimum GILTI tax in 2017 to discourage the practice of profit-shifting to low-tax jurisdictions. But it came with sweeteners that removed a lot of the sting for corporate taxpayers, including a lower overall corporate tax rate. Biden’s plan eliminates the sweetener by raising the minimum GILTI rate to 21%, broadening its base, and simultaneously increasing the general corporate tax rate.
The Tax Foundation estimates that the higher GILTI rate and the broader base being imposed will result in $532 billion in additional federal tax revenue. It also will likely mean that many companies face a worldwide GILTI tax burden that exceeds the proposed overall U.S. rate of 28%.
The Biden plan also includes several proposals that would limit the ability of U.S. firms to get a credit for tax paid in foreign jurisdictions. Potentially the most onerous provision ends the practice of pooling credits from different countries, which companies have used to reduce their overall tax liability. Adding to the pressure is a series of BEPS (Base Erosion and Profit Shifting) rules, already implemented in Germany, the United Kingdom, and Australia. Those rules target aggressive strategies that reduce the tax base of higher tax jurisdictions.
All of these anti-hybrid rules (meaning those that prevent arrangments that exploit differences in tax treatments) can cause unpleasant surprises when U.S. firms seek to sell foreign holdings. For example, it’s common for U.S. companies to make a “check-the-box” election on a foreign subsidiary, resulting in its corporate treatment in the local country. If a due diligence process raises the issue of potential non-deductible foreign liabilities under anti-hybrid rules, major headaches and a reduced sale price can result.
Rules aimed at preventing inversions, whereby U.S. firms effectively switch to a foreign jurisdiction to avoid U.S. tax, have been on the books since the late 1990s. The Biden plan cuts the stake that former owners of a U.S. target company can have in the acquiring company to 50% from 60%. That is likely to have a chilling effect on these kinds of transactions involving U.S. companies, many of which are not efforts to abuse the system.
Exacerbating the effects of Biden’s plan is the dramatic rise in reporting requirements both in the United States and internationally. Consider Form 5471. In recent years, this document, required for those who have positions or shares in certain foreign companies, has expanded to 26 pages from 6. Make a mistake on this form, and the Internal Revenue Service can hit you with a $10,000 penalty. Meanwhile, the European Union’s DAC6 rules have imposed reporting requirements on intermediaries in cross-border deals involving companies that may be seeking a tax advantage.
The environment described above will require all hands on deck.
CEOs should be ready to undertake a comprehensive vetting of the tax implications of any transaction. Deals with thin profit margins could easily end up underwater, especially if a tax planning team commits avoidable mistakes. CFOs, whose job it is to build the infrastructure of intercompany transactions and make sure reporting is efficient, will need to be more careful and thoroughly think through the new rules’ implications. The explosion of reporting requirements internationally means that any unforeseen results of reporting choices risk being more expensive and less reversible than traditionally.
Bill Henson is a partner at Plante Moran, specializing in international tax planning.